Building Momentum in Venture Capital Across Europe – France, Germany, Italy, Spain and the United Kingdom

Editor Dr Georg Metzger (KfW)

Layout and Design Bettina Apfelbach (KfW) Iris Brandt (KfW)

Picture Credits Getty Images / Photograf Westend61

December 2016 Table of Contents

Greetings 5

Foreword 7

1. General Part 11 1.1 Venture capital: what it is and why it is important 13 1.2 The EU venture capital market 14 1.3 Fostering the European VC market 23 1.4 Recommendations for building momentum in the venture capital markets in Europe 26

2. Country Reports 29 2.1 France 31 2.1.1 Development of the VC market 31 2.1.2 Role of public institutions 32 2.1.3 Specific challenges and needs 33 2.1.4 Policy recommendations 34 2.2 Germany 35 2.2.1 Development of the VC market 35 2.2.2 Role of the national development bank 37 2.2.3 Specific challenges and needs 38 2.2.4 Policy recommendations 40 2.3 Italy 41 2.3.1 Development of the VC market 41 2.3.2 Role of public financial institutions 43 2.3.3 Specific challenges and needs 44 2.3.4 Policy recommendations 46 2.4 Spain 47 2.4.1 Development of the VC market 47 2.4.2 Public policies in VC 48 2.4.3 Specific challenges and needs 49 2.4.4 Policy recommendations 51 2.5 United Kingdom 53 2.5.1 Development of the VC market 53 2.5.2 Role of the national development bank 54 2.5.3 Specific challenges and needs 56 2.5.4 Policy recommendations 56

References 59

Appendix 61

List of Figures

Figure 1: Fundraising of VC firms in the EU hit hard by financial crisis 15 Figure 2: Government agencies most important source of VC funds in Europe 15 Figure 3: Venture investments by VC firms located in the EU almost halved after 2008 16 Figure 4: Divergent development of VC investments in selected countries 17 Figure 5: VC investments rates in the United States far ahead of EU countries 18 Figure 6: UK accounts for a quarter of the EU VC market 18 Figure 7: Average VC-backed US company receives five-times more VC than its EU counterpart 18 Figure 8: VC investment in Top 10 OECD VC markets by stages of investment, 2014 19 Figure 9: Breakdown of average VC deal size, 2015 19 Figure 10: Venture capital invested at company level by stage and number of deals 19 Figure 11: Number of VC deals in the United States by stage, 2015 20 Figure 12: VC investment by stages, USA and Europe, 2015 20 Figure 13: Venture capital invested at company level and number of deals 21 Figure 14: Breakdown of average VC deal size over the last 5 years 21 Figure 15: Total amount rose by VCAP funds of funds 22 Figure 16: Breakdown of total VC funds invested by stage, in per cent, 2015 22 Figure 17: Annual average exit size for deals above CAD 100 m, 2011–2015 22 Figure 18: Amounts invested in French VC funds by investor type 31 Figure 19: Less French funds raise more capital 31 Figure 20: Investments by French VC firms 32 Figure 21: Investments in French companies 32 Figure 22: Performance of French VC funds since origin 33 Figure 23: Evolution of divestments in the Spanish VC sector (number) 34 Figure 24: Evolution of divestments in the Spanish VC sector (amounts) 34 Figure 25: Government, corporates and private individuals fund the German VC market 35 Figure 26: Fundraising of German VC firms 36 Figure 27: Investments by German VC firms 36 Figure 28: VC investments into German companies 36 Figure 29: Development of business climate and demand in German VC market 37 Figure 30: Development of exit activity 38 Figure 31: Exits by sale of silent partnerships dominate and write-offs account for 80 % of deals 39 Figure 32: Post-crisis IPOs in Germany still few, while IPOs in the US recovered fast 39 Figure 33: US companies fuelled with significantly more VC – at every development stage 40 Figure 34: Fundraising of Italian VC firms 41 Figure 35: Investments by Italian VC firms 42 Figure 36: VC investments into Italian companies 42 Figure 37: VC divestments by exit route 45 Figure 38: IPOs at Borsa Italiana 45 Figure 39: Total funds raised by Spanish VC firms 47 Figure 40: Investments by Spanish VC firms 48 Figure 41: VC investments into Spanish companies 48 Figure 42: Investments of Fond-ICO Global and of other investors in the Spanish VC market 49 Figure 43: Average fund size of Spanish private equity companies 50 Figure 44: Volume of VC divestments in Spain 50 Figure 45: Number of VC divestments in Spain 50 Figure 46: VC investment rate fell to a low level 51 Figure 47: Venture Capital Funds raised per year by fund stage focus 53 Figure 48: VC investments into UK companies 54 Figure 49: VC investments by UK VC firms (funds) 54

France, Germany, Italy, Spain and the United Kingdom

Building Momentum in Venture Capital across Europe Greetings

“Europe's economy is about the same size as that of the US, but our capital markets are only half their size. Our corporate bond market is a third of the size; our venture capital markets a fifth. US SMEs get about five times more funding from capital markets than in Europe.“ (Lord Hill speaking at the Bruges European Business Conference on 18 March 2016).

These figures only partially describe the challenges facing the European Union today. The tightening of banking regulations affects traditional lending to SMEs. The weak balance sheets of some financial institutions, the ageing population, growing competition in the area of innovation, the shortening of investment cycles, and the emergence of new competitors around the world are just a few of the issues we face.

National Promotional Banks and Institutions have for many decades played an important role in financing start-ups. As a result, we have acquired considerable insight into our respective markets and have closely followed their developments. Part of this is brought together in this report in order to benefit from each other’s experience.

Having done so, we hope to contribute to the Venture Capital debate taking place within the European Commission, but also within other EU institutions and in our respective countries. What can be done to overcome the large fragmentation of the Venture Capital market in the EU? What are the success factors for Venture Capital funds in the EU in comparison to those in North America? And not least, to what extent can national and EU financial instruments help EU start-ups to rise to innovation and growth challenges? These and many other questions have been addressed in this joint study.

Nicolas Dufourcq Dr. Fabio Gallia Directeur Général of Bpifrance Chief Executive Officer of Maisons-Alfort Cedex, France Cassa depositi e prestiti SpA Rome, Italy

Pablo Zalba Bidegain Dr Ulrich Schröder Chief Executive Officer of Chief Executive Officer of Instituto de Crédito Oficial KfW Bankengruppe Madrid, Spain Frankfurt am Main, Germany

Keith Morgan Chief Executive Officer of British Business Bank Sheffield, United Kingdom

Foreword

Innovation is changing the world, producing new opportunities to which we must continually adapt if we are to play a key role in the global economy. If Europe is to be successful in developing the significant technologies of the future and realising their benefits in global markets, our capacity for innovation needs to increase and the skill level of our workforce must improve.

Strengthening the foundation of innovative, growth-oriented start-ups and providing the best conditions for their development is, therefore, more necessary than ever. Access to venture capital is an important success factor for these enterprises. However, the size and depth of European venture capital markets lag behind those of other leading global economies. For instance, the amount of venture capital provided by US investors to start-ups amounts to 0.211 % of GDP per annum on average – more than seven times the EU average. Within Europe, venture capital markets in individual countries also vary greatly in terms of their size and stage of development.

Public interventions significantly contribute to the functioning of European venture capital markets and play an important role in helping them develop into more stable and liquid markets, increasing their positive effects on the wider economy. As we can learn from US pioneer experien- ces, this is a long-term mission.

This report on the national venture capital markets in Europe is the second cooperative research project by the promotional banks of the four largest Euro area economies – Bpifrance, KfW Bankengruppe (KfW), Cassa Depositi e Prestiti (CDP) and Instituto de Crédito Oficial (ICO). This year, the British Business Bank, the UK’s national development bank has joined the group, providing first-hand knowledge and experience regarding Europe’s largest VC market. The Business Development Bank of Canada (BDC) also contributed its insights into North American venture capital markets.

As promotional banks for our respective countries, improving finance for innovation is a common key priority and we consider promoting venture capital to be an important factor for the development and growth of innovative businesses. Innovation systems and venture capital markets in each of our countries are very diverse. We have compiled this report in order to learn from each other’s knowledge of domestic venture capital markets and identify ways of tackling common market challenges.

Young innovative companies will shape Europe’s future. If Europe is to catch up with the most successful and competitive regions of the world, it needs stronger venture capital markets. As promotional banks, we share our understanding and commitment to support venture capital markets and to increase Europe’s capacity for innovation and competitiveness in the future.

Philippe Mutricy Prof Edoardo Reviglio Chief Economist of Bpifrance Chief Economist of Masinsons-Alfort Cedex, France Cassa depositi e prestiti SpA Rome, Italy

Blanca Navarro Dr Jörg Zeuner Chief Economist of Chief Economist of Instituto de Crédito Oficial KfW Bankengruppe Madrid, Spain Frankfurt am Main, Germany

Matt Adey Director of Economics of British Business Bank Sheffield, United Kingdom

1. General Part

1.1 Venture capital: what it is and why it is VC is generally provided by VC funds, which rely on important two types of actors: How venture capital works Technological changes are reshaping the global • “Limited Partners” (LP) who provide almost all of a economy. Promoting innovation is thus, more than funds’ capital. These investors are mostly large ever, a priority for business leaders and governments. financial institutions (e.g. pension funds, banks, New technologies and innovative business models insurance companies, funds of funds), family offices improve efficiency and productivity, ultimately fostering (managing the assets of wealthy individuals) or public economic growth. This has increased the attention paid institutions. to innovative companies and the ways of promoting their development. • “General Partners” (GP) who provide a marginal share of a funds’ capital (often 1 %)2, but who together There is a consensus in economic literature that young with their management team, are the funds’ decision innovative companies face important financial con- makers. They make the investments and monitor the straints, especially with regard to debt financing.1 investee companies. GPs own a VC firm, often These companies possess high growth potential but managing several funds at once. are also susceptible to failure due to their higher technology and market risks. Their chances of success VC funds generally have a fixed maturity (about ten are therefore difficult for lenders to assess (information years) and follow a classic investment pattern: they asymmetries). As their income prospects are highly invest their funds over a 3–5 year period, after which uncertain and they typically lack collateral, young they monitor their portfolios and eventually make innovative companies are more likely to be affected by follow-on investments in the most promising credit rationing. companies. In the final years of the investment term, VC firms have to divest in order to generate a financial Venture capital (VC) is a chance for young innovative return for their investors. Potential buyers of their companies to overcome these challenges. As equity investment portfolio include other funds (exit via holders, VC investors participate directly in the secondary sale), industrial firms which for example, are increasing business value of successful companies. seeking to acquire and develop a new technology (exit Unlike lenders, they are thus able to weigh their higher via trade sale), or public markets by listing on a stock risks against increased opportunities. Furthermore, VC exchange (exit via IPO). However, given the high level investors are able to mitigate information asymmetries of risk involved, the most common outcome for a VC- by closely screening and monitoring investee firms: backed company is failure (meaning a negative return up to total loss). Return-oriented VC firms need to • VC firms employ highly skilled specialists with compensate for these losses by aiming to make very expertise in the business sector of their investment high returns on a small number of their most promising targets (industry’s economic environment, existing investments. technologies, competition etc.). These institutional VC firms co-exist with informal • Once they have invested in a company, VC investors investors, such as business angels. Angel investors are usually have seats on the companies’ boards and are typically wealthy individuals and / or former business often involved in the firm’s daily operational life, i.e. leaders who invest their own personal resources in they manage their portfolio companies “hands-on”. young innovative companies and in addition provide their own management expertise to the investee • VC investors frequently disburse funds in stages, companies. These investors are complementary to VC with additional funding being contingent on the firms because they generally focus on the earliest achievement of operational and financial objectives. stages of a company, invest smaller amounts, and can This “staging” process allows them to reduce have other motives than just financial returns, such as information asymmetries and to align the interests of altruistic reasons or the desire to create new busi- the VC firm and the founders of the company they have nesses. Therefore, angel investors can bring new invested in. companies to the level of development where they become interesting investments for VC firms.

1 See e.g. Hall (2002) for theoretical arguments. 2 See Mulcahy et al. (2012).

Page 13 Building Momentum in Venture Capital across Europe

Compared with other sources of finance, the VC The positive correlation between VC and innovation is market is very narrow. For example, according to a well-established fact.7 However, causality can go Invest Europe, VC funds in the five countries both ways: On the one hand, VC activity can contribute considered in this report (France, Germany, Italy, to the launch of new products on the market. On the Spain, and the United Kingdom) had EUR 39 bn in other hand, VC activity is driven by the occurrence of assets under management in 2015, while the total investment opportunities and expectations regarding amount of outstanding loans in these countries amoun- the technological development.8 ted to EUR 3,500 bn as reported by the ECB. Kraemer- Eis et al., (2016), pointed out that VC is not a 1.2 The EU venture capital market “substitute for traditional, mainly bank-centred, SME • The EU VC market has raised EUR 40 bn since financing instruments”; instead, it should be seen as 2007, government agencies being the most a specific financial instrument for young innovative important contributor. companies. • VC firms located in the EU financed more than The importance of VC 28,000 young companies within nine years providing The availability of VC funding is considered to be a a total of EUR 35 bn in venture capital. crucial element for the survival and development of high potential companies and their ability to overcome • UK accounts for a quarter of the EU VC market. the so-called “valley of death”. This “valley of death” The long-term impact of the “Brexit” on the VC represents the shortage of financial resources and the market is unknown and will depend on how the VC lack of business development knowledge that industry responds to the new economic conditions. characterises start-up projects.3 To overcome these obstacles, VC firms provide not only funds, but also Development of the VC market various types of expertise (e.g. human resources, According to Invest Europe’s VC market activity data finance, legislation, business strategy, or intellectual (see Box 1), VC firms in the EU raised funds of about property) and access to their networks. The partici- EUR 40 bn between 2007 and 2015. In 2007, more pation of a VC firm can also help to improve a than EUR 7 bn of funding was raised. However, in company’s reputation and lead to an increase in 2008 fundraising slumped to below EUR 5 bn, falling confidence on the part of other investors, initiating a further to its post crisis low of about EUR 3 bn in 2009 virtuous circle between VC investment and perfor- and 2010 (Figure 1). Then, in 2011 fundraising mance. recovered to more than EUR 4 bn. This was due to a catch-up effect by investors who held off investing Empirical studies support this view: they show that VC- during the most critical phase of the financial crisis. backed companies exhibit higher growth in sales, However, in 2012 fundraising fell back to below employment and productivity.4 Despite the narrowness EUR 4 bn before climbing to about EUR 5 bn in 2015. of the VC market, studies find a positive correlation between VC activity and innovation at the industrial and country level.5 Thus, the positive stimulus of VC on the growth of young companies translates into increased growth and innovation at the macroeconomic level, not only in the countries where these companies are located but also in the countries in which they and the VC firms operate. Particularly cross-border deals can stimulate such diffusion. Prior to the financial crisis, cross-border deals accounted for a third of the total number of deals worldwide.6

3 See Savaneviciene et al. (2015).

7 4 See the reviews of Da Rin et al. (2011), Savaneviciene et al. (2015), See Tykvová et al.(2012) or Da Rin et al. (2011) for a review. Tykvová et al. (2012) or Kraemer-Eis et al. (2016). 8 Arqué-Castells (2012) shows that VC funds select firms that are already 5 See Kortum and Lerner (2000) and Popov and Roosenboom (2009). innovative, accelerating the market launch of these firms’ products. Bernstein et al. (2015) shows that active monitoring by VC managers leads to a positive 6 See Schertler and Tykvová (2009). impact on innovation and the probability of an IPO.

Page 14 General Part

Most of the EUR 40 bn raised since 2007 was Box 1: VC market activity data of Invest Europe dedicated to be invested in companies which are at an As VC firms are not obligated to inform about their early stage of development (i.e. seed or start-up stage, activities, there are no official VC statistics. All VC 9 46 %). About every tenth Euro was assigned to be data sources available are based on voluntary invested in later stage ventures (12 %), while no declarations of VC firms or on the market monitoring specific target stage was assigned to 42 % of the funds. of data providers. Thus, VC activity differs depending on the data source used. Figure 2: Government agencies most important source of VC funds in Europe The data used in this report was supplied by Invest Europe (before 1 October 2015 known as European Sources of VC fundraising in per cent, average 2007–2015 Venture Capital Association, EVCA). Invest Europe Corporate investors is an association for Europe’s private equity, venture Government capital and infrastructure sectors, as well as their 11 agencies investors. Invest Europe supplies industry and Other 22 market data for all European countries, thus sources providing a consistent data base. Industry statistics 10 show investments of VC firms located in Europe; the market statistics present VC investments in 10 Private European companies. The industry statistics thus individuals include the investments of European investors in 22 non-European countries while excluding the 8 Fund of investments of non-European investors in Europe Unclassified 7 funds 5 5 Pension Data on private equity fundraising, investment and funds divestment by more than 1,800 private equity firms in Family Banks offices Europe is gathered via PEREP_Analytics, which is a joint Pan-European statistics platform owned by Note: The numbers refer to the whole of Europe including Norway, Invest Europe and several European private equity Switzerland and the Ukraine, because it is not possible to extract associations. According to Invest Europe, the 2015 numbers only for the EU on the basis of the available information. statistics cover 91 % of the roughly EUR 560 bn Source: Invest Europe / PEREP_Analytics capital under management in the European market. Government agencies play an important role in European VC fundraising. Since 2007, they have Source: www.investeurope.eu contributed more than a fifth of the total funds committed to VC firms in the EU (Figure 2). No other Figure 1: Fundraising of VC firms in the EU hit hard investor provides that amount of VC funding. Corporate by financial crisis investors and private individuals provide about 10 % Fundraising in EUR m each, i.e. together roughly the amount that government 9,000 agencies contribute. Other private investors such as banks, insurers or pension funds provide only small 8,000 portions of the overall funding. This shows that stimu- 7,000 lating private VC funding is one of the most important

6,000 challenges the European VC market faces. By comparison, in the United States, public authorities are of 5,000 minor importance and pension funds are the most 4,000 significant source of VC funding.10 3,000

9 2,000 See Appendix Table 2 for stage definitions.

10 1,000 See Brigl and Liechtenstein (2015) who compared the European and US VC investor landscapes in 2014. However, in their analysis of VC investors’ 0 contributions, they neglect unclassified funds in the European data. Doing so, 2007 2008 2009 2010 2011 2012 2013 2014 2015 they presume inherently that the unclassified funds distribute identically to the funds assigned to an investor group which is a bold assumption. It is rather to Early stage Later stage venture Balanced be supposed that e.g. public funds are fully classified, thus indicating that the authors underestimated private sources like pension funds. Furthermore; they Source: Invest Europe / PEREP_Analytics report a share of US government contributions to VC funds of zero. However,

Page 15 Building Momentum in Venture Capital across Europe

Since 2007, VC firms located in the EU have financed Box 2: The financial performance of VC funds more than 28,000 companies with about EUR 35 bn. The “2013 Pan-European Private Equity Annual investments reached EUR 5–6 bn in both 2007 Performance Study” shows remarkable differences and 2008 (Figure 3). Then in 2009, when the financial in the performance of private equity funds dependent crisis became evident, VC investments plunged to on the funds’ investment focus, vintage year but also about EUR 3.5 bn a year and remained at this level location.12 It is based on a total sample of 1,455 in- until 2011. In 2012 and 2013 VC funding fell to a ternational independent funds set up between 1980 temporary low of slightly more than EUR 3 bn, but and 2013, which were recorded in the ThomsonOne gradually recovered to 2011 levels by 2015. At the database in June 2013. beginning of the period being considered, EU VC firms financed as many as 4,000 deals. Thereafter, however, Firstly, the study shows that on average, VC funds the number fell to about 3,000 deals a year, stagnating are less profitable for investors than buyout funds. at this level until 2013. In 2014 the number rose, but Overall, from their inception to end of 2013 the funds then dropped significantly to below 3,000 deals in reached a net-pooled internal rate of return (IRR)13 2015. of 9.24 %, whereas VC funds performed clearly worse (1.68) than buyout funds (11.41). Accordingly, Figure 3: Venture investments by VC firms located the Total-Value-to-Paid-In-multiple for VC funds is in the EU almost halved after 2008 1.1 compared to 1.42 for buyouts funds. Investments in EUR m Number of deals

7,000 4,500 Secondly, the performance of the VC funds is highly dispersed. By the end of 2013, the pooled IRR for 4,000 6,000 the top-quarter VC funds was 18.51 and for the top- 3,500 half 11.28. Many VC funds were thus able to 5,000 3,000 generate significant returns for their investors; however, given the median IRR of -1.30, the majority 4,000 2,500 of VC funds exhibit negative returns. 3,000 2,000 1,500 This dispersion can be related to differences in the 2,000 1,000 vintage years of the funds. Pooling cash flows of all 1,000 VC funds hides the fact that some funds are at the 500 beginning of their investment cycle (and therefore 0 0 have not distributed to their LPs yet so their returns 2007 2008 2009 2010 2011 2012 2013 2014 2015 are computed on an estimated value), while others Seed Start-up Later stage venture Number of companies are mature or even terminated (their financial returns Source: Invest Europe / PEREP_Analytics are thus realised). The study shows, thirdly, that VC funds of older vintage years (1980–1994) exhibit Of the EUR 35 bn invested from 2007 to 2015 VC firms higher returns than funds of more recent vintage provided 4 % to companies in the very early seed years. In contrast, buyout funds yield considerable stage. These firms used the capital for activities like 11 returns up to vintage year 2004. research or for developing an initial concept. Start-up ventures, which need financing for product develop- Finally, the study shows that European VC funds ment and initial marketing, and later stage ventures, generate lower returns than US VC funds. European which want to trigger their first expansion, received the VC funds exhibit continually lower horizon IRRs than bulk of the capital in almost equal parts (47 % and US VC funds, regardless how many previous years 49 %). (one, three, five or ten) are considered: the average 10-year IRR 14 of European VC funds by the end of 2013 is 0.84 for European VC funds, compared to

12 EVCA (2014).

US public authorities provide funds to so called registered ‘Small Business 13 The “pooled” IRR is based on all funds’ cash flows since inception and their Investment Companies‘ (SBICs) via the Small Business Administration (SBA) residual value, which are aggregated in one pool. and within the framework of the State Small Business Credit Initiative 14 (SSBCI), see Box 3 for details. A fund’s 10-year horizon IRR for example by the end of 2013 is based on its residual value at that time, its net asset value by the end of 2003, and its cash 11 See Appendix Table 2 for stage definitions. flows in between.

Page 16 General Part

5.03 for US VC funds. In contrast, EU buyout funds Figure 4: Divergent development of VC investments performed slightly better (10-year IRR: 10.46) than in selected countries their US counterparts (9.64). Index [2007=100]

200 The VC performance gap between the United States and Europe has not been fully resolved. However, 180 the fact that European VC markets are much 160 younger than the US VC market seems to be one 140

explanation: VC firms and entrepreneurs are less 120

experienced, VC is not firmly established as an asset 100 class for investors, and exits are more difficult. This 80 hypothesis might be confirmed by the most recent development. Hence, the 5-year rolling IRR for 60 European VC shows a slight improvement. In 2013, 40 the figure was the highest since the burst of the dot- 20 com bubble. 0 2007 2008 2009 2010 2011 2012 2013 2014 2015

EU Germany France Italy Spain UK USA* VC investors are focused on EU innovative young companies within three main sectors: life sciences, * See Note Figure 5 for different VC definitions. computer & consumer electronics and communications. Source: Invest Europe / PEREP_Analytics, own calculations. These sectors attract about 60–70 % of total VC each Since 2007, VC investments in the EU have an year. Since 2007, about 25–35 % of VC has flowed into average equivalent value of around 0.028 % of GDP life sciences companies, whereas the sectors per year (Figure 5). In the UK and France, VC invest- computer & consumer electronics (20 %) and ments reach a level of 0.046 and 0.038 % of GDP per communications (15–20 %) have received up to a fifth annum. Germany shows VC investments of 0.029 % of each. Until 2012, 10–16 %, a significant part, of VC GDP every year and is only slightly above the EU investments flowed into the energy & environment average. Spain and Italy, where companies receive VC sector. However, its importance has decreased corresponding to 0.018 and 0.005 % of GDP, have the significantly, so that it only gained 4 % of VC invest- lowest relative share of GDP in comparison with the ments in 2016. other countries listed. Compared to the US VC market, these European numbers appear small. US investors EU VC market is highly fragmented provide VC for companies accounting for 0.211 % of The European aggregate hides the fact that VC GDP per annum on average – more than sevenfold the markets in individual European countries are very EU average. Because the US VC market experienced diverse in terms of development stage, size and trends. an additional boom in the last two years (see Box 3), its Diverging national legal and regulatory regimes as well GDP share in 2015 was almost fourteen times higher as innovation systems have led to highly fragmented than that in the EU. and diverse VC markets. Figure 4 shows the divergent development in the five largest EU countries (as The high level of US VC relative to GDP is out of reach measured by GDP) France, Germany, Italy, Spain and for most European countries. Closest to the United the UK since 2007. As mentioned above, VC invest- States, but still far behind, is the UK VC market, which ments in the EU fell by almost two-fifths in 2009 and forms a significant proportion of the EU VC market: it have remained at roughly this level. accounts for a quarter of all EU VC fundraising and investments (Figure 6). The result of the UK’s referen- Of the European countries considered in this survey, dum on EU Membership has increased economic VC investments in Germany developed best, reaching uncertainty in the short and medium term. The long- the 2007 level by 2015. In comparison, VC investments term impact of the decision to leave is unknown at this in Spain and Italy were hit hard over the last few years stage and will depend, to some extent, on what the falling to approximately 40 % of their pre-crisis levels. In “Brexit” looks like. It will be important to closely monitor France and the UK, VC investments developed simi- how the VC industry responds to the new economic larly to the European average in 2015 – reaching 60 % conditions and to ensure that young, growing com- of 2007 levels. These developments stand in sharp panies across Europe are able to access the venture contrast to the dynamics of the US market, where VC capital financing they need. investment tripled by 2015 after its setback in 2009.

Page 17 Building Momentum in Venture Capital across Europe

Figure 5: VC investments rates in the United States Figure 7: Average VC-backed US company receives far ahead of EU countries five-times more VC than its EU counterpart VC investments in per cent of GDP, average 2007–2015 Mean deal size* in EUR m, average 2007–2015

7 USA 0.211 6.3 6 UK 0.046

5 France 0.038

4 Germany 0.029

3 EU 0.028 2.4 2.0 1.9 2 1.7 Spain 0.018 1.3 1 0.9 Italy 0.005

0.000 0.050 0.100 0.150 0.200 0.250 0 Germany EU Spain Italy France UK US

Note: Invest Europe and NVCA apply different VC definitions. For the * Deal size per financing round EU countries, the numerator of the yearly VC investments rates represents the aggregated investment volumes of seed-, start-up and Note: The value for Germany includes financings by Mittelständische later stage venture capital in each year reported by Invest Europe. Beteiligungsgesellschaften which provide a high number of smaller The numerator of the US-rates includes seed stage, early stage, financings (see German country chapter for details). expansion stage and later stage financings reported by NVCA. See Appendix Table 2 for a comparison of VC definitions by Invest Source: Invest Europe / PEREP_Analytics, Europe and NVCA. PricewaterhouseCoopers / National Venture Capital Association MoneyTree™ Report Q2 2016, own calculations. Source: Invest Europe / PEREP_Analytics, PricewaterhouseCoopers / National Venture Capital Association EU VC markets differ not only in relative and absolute MoneyTree™ Report Q2 2016, US Bureau of Economic Analysis, sizes, but also in size of investments. On average, VC own calculations. firms invest EUR 1.3 m in companies located in the EU Figure 6: UK accounts for a quarter of the EU during in each funding round. In the countries VC market considered, German companies are backed by the Market share in EUR lowest amount, receiving EUR 900,000 (see note of Fi- gure 7). Spanish (EUR 1.7 m), Italian (EUR 1.9 m), IT French (EUR 2.0 m) and British (EUR 2.4 m) com- New venture funds raised 0.7 bn by country of the fund management FR DE OEU UK 9.7 bn 7.5 bn 10.1 bn 10.0 bn panies receive a higher amount. Also, average VC deal (EU total '07–'15: EUR 39.7 bn) ES size in the EU is significantly smaller than that in the 1.7 bn United States where VC-backed companies receive an

IT average of EUR 6.3 m in each financing round. The Venture investments 0.5 bn by location of PE Offices FR DE OEU UK larger size of the US capital market may explain some 7.6 bn 6.7 bn 10.3 bn 8.7 bn (EU total '07–'15: EUR 35.4 bn) ES of this difference. The fact remains, however, that the 1.6 bn

UK ~UK One Quarter potential of US companies to push their business

IT model, technology and market penetration (i.e. market 0.7 bn Venture investments share) is much better. by country of portfolio company FR DE OEU UK 6.9 bn 6.8 bn 9.9 bn 8.3 bn (EU total '07–'15: EUR 34.4 bn) ES 1.8 bn

0 % 25 % 50 % 75 % 100 %

Note: FR=France, DE=Germany, IT=Italy, ES=Spain, UK=United Kingdom, OEU=Other EU-countries Source: Invest Europe / PEREP_Analytics, own calculations.

Page 18 General Part

Box 3: The North American VC market – a bench- The US VC market experienced phenomenal growth mark comparison after the low reached in 2009. VC investment grew at Pierre Cléroux, Vice President, Research and Chief Economist a compound annual growth rate of 19 % over that Business Development Bank of Canada (BDC) period, while the number of deals jumped by 38 % (Figure 10). An American Success Story The United States is by far the largest VC market in Figure 10: Venture capital invested at company the world. In 2015, 4,380 deals totalling USD 59.1 bn level by stage and number of deals were made, half of which were attributable to Investments in USD m Number of deals California alone. In comparison, 3,006 deals were concluded in Europe, for a total of USD 4.4 bn. As a 60,000 6,000 percentage of GDP, the volume of US VC investment 50,000 5,000 ranks second only to that of Israel (Figure 8), but the average deal size in the United States surpassed that 40,000 4,000 in the “start-up nation” by USD 5 m (Figure 9). 30,000 3,000 Figure 8: VC investment in Top 10 OECD VC markets by stages of investment, 2014 20,000 2,000

VC investments as share of GDP in per cent 10,000 1,000

0.45 0 - 0.40 0.38 2009 2010 2011 2012 2013 2014 2015 0.35 0.28 Seed Early Stage Expansion Later Stage Number of deals 0.30 0.25 Source: PricewaterhouseCoopers/National Venture Capital 0.20 Association MoneyTree™ Report Q1 2016. 0.15 Breakdown by region and industry 0.10 0.08 0.07 0.06 0.06 0.05 0.04 0.04 Three states account for 77.5 % of the total VC 0.05 0.03 invested in 2015: California, Massachusetts and New 0.00 York. As mentioned previously, California alone accounted for more than 57 % of the market, most of it driven by Silicon Valley, home of the largest technology ecosystem in the world. Seed/start-up/early stage Later stage venture Source: OECD, “Entrepreneurship at a Glance 2015”, OECD By sector, the majority of investment occurred in iLibrary. software (40 %), life sciences (19 %) and other ICT, Figure 9: Breakdown of average VC deal size, excluding software (11 %). 2015 Average deal size in USD m Investment by stage

16 In 2015, the majority of VC investment went into expansion and later stages (64 %), while the early and 14 13.4 seed stages accounted for 34 % and 2 %, respect-

12 tively. However, a closer look at the number of companies funded by stage reveals that the majority 10 of deals (2,405 or 55 %) were at the seed and early 8.1 8 stages (Figure 11). Of those, 1,444 raised VC for the first time, which led the NVCA to affirm that the US 6 VC industry remains focused on the next generation i 4 of “great” US companies. In comparison, more than half of European VC money went to the early stage 2 (Figure 12). 0 USA Israel Source: PricewaterhouseCoopers / National Venture Capital Association MoneyTree™ Report Q2 2016, IVC.

Page 19

Building Momentum in Venture Capital across Europe

Figure 11: Number of VC deals in the • The US capital market offers VC-backed United States by stage, 2015 companies opportunities to exit via IPOs. In 2015, Seed 18 % of exits were through IPOs in the United States. Later Stage As a general rule, IPOs are more lucrative than trade 186 sales. 829 4 % 19 % • US venture capitalists are very experienced and focus on later stages. Many have run a start-up themselves and know how to scale up a business. 2,219 Thus, they favour investment in companies that have 1,146 51 % proven markets. Expansion 26 % Early Stage Role of the Public Sector Public sector involvement has played a major role in shaping the US VC industry, as shown by Lerner Source: PricewaterhouseCoopers / National Venture Capital (2009). The pioneers of Silicon Valley benefited from Association MoneyTree™ Report Q1 2016 public funding of universities and defence at the th Figure 12: VC investment by stages, USA and beginning of the 20 century. This public spending Europe, 2015 continues to support the innovation process of the US economy, even nowadays, by fostering the demand Share of stages in per cent for VC.

USA 2 34 64 The federal government’s Small Business Investment Companies (SBIC) program is the principal policy tool for supporting VC in the United States. The

Europe 3 52 45 government does not invest in promising small businesses directly; instead, it offers loans to SBICs. SBICs – privately owned and managed investment 0 20 40 60 80 100 funds – then use their own capital and government- Seed Early Stage Later Stage & Expansion backed loans to invest in the equity and debt of iii iv Source: PricewaterhouseCoopers/National Venture Capital qualifying small businesses , like Apple in 1978. Association MoneyTree™ Report Q1 2016 and Invest Europe / PEREP_Analytics. For each dollar an SBIC raises from private investors, Economic Impact the federal government commits up to USD 2 of debt, Three out of the five largest US public companies up to a maximum of USD 150 m per SBIC. From 2011 based on market capitalization – Apple, Google and to 2015, the SBIC program helped secure a total of Microsoft – received VC at the early stage. Moreover, more than USD 21 bn in financing for about 5,800 42 % of all public companies founded after 1974 were small businesses.v venture-backed. Together, these companies represented 63 % of the capitalization and 85 % of all At the state level, the Obama administration R&D spending by public companies formed since introduced the State Small Business Credit Initiative 1974.ii (SSBCI) as part of the Small Business Jobs Act of 2010. The USD 1.5 bn initiative aims to strengthen vi Success factors VC programs. Some states allocated the money to • The United States has large VC funds. There existing VC initiatives, while others created new VC were a total of 1,224 funds in existence in the USA by programs. Those initiatives mainly consisted of direct 2015, with an average size of USD 135 m. The larger investment funds or funds of funds initiatives. the fund, the easier it is to raise capital, develop expertise in a specific technology niche, and fund large deals. There can also be economies of scale from operating larger funds as the administration costs (i.e. overhead) of operating an office represent a smaller percentage of the total capital committed.

Page 20 General Part

Mobilising private VC by public funds of funds: Figure 14: Breakdown of average VC deal size Canadavii over the last 5 years Average deal size in CAD m Overall, the Canadian venture capital (VC) market is 18 well established and has been growing both in terms 17.1 of the number of deals and the amount of money 16 invested; however, the average deal size is small 14 12.6 compared to that in the United States. In 2015, a total 12 of CAD 2.7 bn in venture capital was invested in 10.3 Canadian companies, the best result since 2002. 10 8 7.3 7.3 According to the OECD, the volume of Canada’s VC 6.9 6.4 6.6 5.6 investment as a percentage of GDP ranked third 6 5.3 5.2 4.7 amongst other developed nations – at 0.08 % of GDP 4.2 4.5 4.3 4 – only behind Israel (0.38 %) and the USA (0.28 %), the homes of more mature VC markets (Figure 8). 2 0 The Canadian VC market came out of the 2008–2009 2011 2012 2013 2014 2015 USA Canada Israel global economic crisis well. Both the number of deals and the size of the financing have boomed over the Source: CVCA, PricewaterhouseCoopers / National Venture Capital last five years (Figure 13). VC investment grew at an Association MoneyTree™ Report Q1 2016, IVC. average rate of nearly 18 % between 2011 and 2015, By sector, firms in information and communication while the number of deals went from 207 in 2011 to technologies (ICT) have captured the largest share of 536 in 2015, up 159 %. However, average deal size VC investment in Canada (63 %), followed by life fell 33 % over the same period, from CAD 6.4 m in sciences (29 %) and clean technologies (6 %). The 2011 to CAD 4.3 m in 2015. By comparison, both the majority of VC investment occurs in early-stage USA and Israel have expanded the amount of capital growth (51 %), while 42 % occurs in the expansion or per investment – by 135 and 83 % respectively – later stage of the business life cycle. The remaining providing greater resources for growth (Figure 14). 7 % of investment consists of seed or start-up This was not the case with Canada, where most VC viii capital. money went to earlier stages of investment at the expense of later stages. The Role of Public Institutions The public sector plays an important role in the Figure 13: Venture capital invested at company Canadian VC market. In 2013, the federal level and number of deals government launched the Venture Capital Action Plan Investments in CAD m Number of deals (VCAP), a CAD 400 m initiative to support the

3,000 600 Canadian VC ecosystem. This initiative aims to draw private sector capital back into this asset class by 2,500 500 investing in four large-scale funds of funds led by the private sector with the participation of institutional 2,000 400 investors, corporate strategic investors, high net worth individuals and interested provinces. For every dollar 1,500 300 invested by the public sector, private sector partners committed CAD 2 to the funds of funds. The Business 1,000 200 Development Bank of Canada manages the VCAP program. 500 100

VCAP has been successful. As of 18 May 2016, the 0 0 2011 2012 2013 2014 2015 program has attracted CAD 904 m in private sector

Amount of VC Number of deals money back into this asset class. Overall, CAD 1.4 bn has been raised with government commitments Source: CVCA. accounting for one third of this amount (Figure 15).

Page 21 Building Momentum in Venture Capital across Europe

Figure 15: Total amount rose by VCAP funds of As a result, the average annual exit size of bigger ix funds deals in Canada was CAD 290 m between 2011and Amount of VC in CAD m 2015, which was nearly half of the US average, also trailing that of other major countries (Figure 17). Given Provincial governments the small size of the Canadian domestic market – there are fewer funds in Canada overall with less available capital to invest compared to other economies – 113 Canada has to rely on foreign investors to secure financing at later stages. Historically, close to half of all Goverment CAD of Canada VC raised at that stage came from foreign investors, 340 x 1.4 bn mostly from US investors. raised by Figure 17: Annual average exit size for deals above VCAP 904 CAD 100 m, 2011–2015 Private sector Amount of VC in CAD m

Note: As of May 18, 2016. It excludes the Government’s CAD 50 m China 569 to existing, high-performing funds, which were all closed as of March 31st 2015. USA 563 Source: BDC.

Specific Challenges Israel 417 The Canadian VC market has difficulty supporting firms in the scaling-up phase of the business life UK 338 cycle. In fact, Canadian investors tend to allocate less capital to later stages of growth, with close to 42 % of total funds invested in that category, compared to Canada 290 64 % in the USA and the United Kingdom, 49 % in 0 100 200 300 400 500 600 Israel (Figure 16) and 45 % in Europe (Figure 12). Canada UK Israel USA China

Source: CVCA, Pitchbook Figure 16: Breakdown of total VC funds invested by stage, in per cent, 2015

Share of stage in per cent

100 7 8 90 1 2

80 35 34

70 43 51 60

50 i PricewaterhouseCoopers / National Venture Capital Association (2016). 40 ii See Strebulaev (2015). 30 64 64 iii 49 The U.S. Small Business Administration. “SBIC Program Overview”, online: 20 42 https://www.sba.gov/sbic/general-information/program-overview 10 iv Mazzucato, M. (2015). 0 v Canada Israel UK USA Dilger (2016).

Expansion & Later Early Seed vi U.S. Department of the Treasury, “State Small Business Credit Initiative (SSBCI)”, online: https://www.treasury.gov/resource-center/sb- Note: Stages of investment depend on national categorization. For programs/Pages/ssbci.aspx Canada, the “Other” category was folded into “Expansion & Later”. vii Brigl and Liechtenstein (2015). Source: CVCA, PricewaterhouseCoopers / National Venture Capital viii Association MoneyTree™ Report Q1 2016, Invest Europe / For Canada, the “Other” category was included in “Expansion & Later”. PEREP_Analytics Source: CVCA.

ix Only deals above CAD100 m were considered for calculating the average. x Data compiled for the 1986–2016 period. Later stages include Series D, E, F, and G. Sources: BDC.

Page 22 General Part

1.3 Fostering the European VC market (health improvement, increase in human capital, The role of public intervention reduction of air pollution). Since private investors do Because of the positive effects of VC activity on not take these “externalities” into account, a case can innovation and economic growth (see part 1.1), be made for the government to invest in companies governments promote various policies in order to which might create such social benefits directly. develop their national VC markets. Indeed, economic literature identifies several mechanisms through which • Second, despite the availability of private funds, public intervention can foster the development of VC some specific projects might continue to suffer as a markets.15 result of information asymmetries between entrepreneurs and investors. For example, since it is First, the VC industry does not develop spontaneously. costly for private investors to collect information about In his famous book in which he reframes public investment projects, they might refuse to consider interventions aiming at developing the VC market, projects which do not reach a certain investment Lerner (2009) describes how, in its infancy, Silicon threshold level. In the same way, they might exclude Valley also benefited from various actions taken by the some emerging sectors from their investment strategy, US government, beginning with defence contracts and because they are not yet able to generate a sufficient public procurement and followed by the Small Business dealflow. Start-ups at the seed stage are most affected Investment Companies program (SBIC). As Lerner by the private investors’ reluctance. By bearing risks shows, creating a viable ecosystem for VC is a learning that private investors are not willing to take, public process, both for entrepreneurs and investors: it investors play an important role: without their requires the creation of new specialized actors (such commitment many entrepreneurs would not succeed to as business angels, incubators, or intermediaries), the start-up and later stage dealflow for private investment dissemination of a risk-taking culture and knowledge would probably run dry. diffusion about investment opportunities. As a sign of this learning process, Giot et al. (2014) show that the • Third, the VC industry is cyclical:16 fundraising and performance of private equity funds tends to increase investment flows quickly react to macroeconomic with their experience, especially during the early indicators and to market expectations regarding stages. investment opportunities. As witnessed during the 2008/2009 crisis, investments in the VC segment tend In particular, a common challenge for governments is to collapse in times of economic recession. This to attract private investors into the VC market, since situation can leave some promising young companies this segment implies large risks and does not yield without any possibility of external funding. In this sufficient short term financial returns (given the learning context, direct public intervention can be a useful process described above). One way of attracting counter-cyclical policy. private investors to the VC segment consists in sharing the risks with them through a “fund of fund” approach: Governments can respond to these “market failures” the government and private investors co-invest in VC with government-owned VC funds. This “direct” funds, which in turn invest in young innovative firms. intervention is complementary to the “fund of fund” The goal of this approach is to demonstrate the viability approach, in the sense that funds of funds do not allow of the VC ecosystem for private investors: in that governments to act in a counter-cyclical way and/or to regard, the invested funds pursue the objective of select projects with lower financial but higher social maximizing financial performance and the government return. remains a minority investor. Although there are several economic justifications for The second justification for public intervention lies in public intervention, the efficiency of this intervention the fact that private investors might not cover all the greatly depends on its design. In particular, it is needs of the economy. In particular, economic important that this type of intervention is effectively literature identifies three reasons for which public targeted on market failures and that its dimension is intervention might improve global welfare: well chosen, in order to avoid adverse effects like a crowding out of private sector VC funds. • First, some projects do not yield high financial returns, but nevertheless have great social value

15 See Kraemer-Eis et al. (2016) for a brief review. 16 See the review of Gompers et al. (2008).

Page 23 Building Momentum in Venture Capital across Europe

Contribution of the National Promotional respectively. To date, FoF VC has already committed Institutions (NPIs) EUR 45 m to four funds and, by acting as anchor Because of the fragmentation and diversity of the investor, it plans to leverage up to EUR 500–600 m. European VC market, common measures which Finally, according to its new Business Plan 2016–2020, strengthen the EU market as a whole as well as CDP is also expected to increase its current commit- precise actions targeting the specific challenges of the ment in VC by launching relevant initiatives in the national markets are needed. This is why national technology transfer (ITAtech) and accelerators development banks such as Bpifrance, KfW, CDP, (AccelerateIT) industries. Under the umbrella of the ICO and the British Business Bank have developed Industry 4.0 Plan17, ideally these initiatives aim at instruments that respond to country-specific issues in matching private investment with resources from the order to support their respective VC markets (see Juncker Plan. country chapters for more details): ICO interventions on the VC market are realized Bpifrance covers all segments on the French VC through Axis, a separate company wholly-owned by market (seed, early and late stage) and intervenes both ICO. Axis, the oldest VC firm in Spain, has invested through several funds of funds and direct investments. more than EUR 879 m in the growth of around Since the end of the 1990s, more than 10 funds of 160 companies and funds since its creation in 1986. funds have been launched and managed by Bpifrance, In connection with VC, Axis mainly operates via three mostly dedicated to VC funds: they have invested vehicles. The first one is Fond-ICOpyme, with an almost EUR 2 bn in more than 130 VC funds, jointly allocation of EUR 250 m (70 % for expansion capital with other private investors. More recently, Bpifrance and 30 % for start-ups) which may be invested through increased its direct investment activity, in order to investments in capital, participating loans or a respond to specific needs of companies in a more combination of both. Another instrument is the Isabel reactive way. In 2014, new direct investments La Católica Fund-EAF Spain, that provides equity to represented about 50 companies and EUR 150 m. business angels and other non-institutional investors for the financing of innovative companies in the form of KfW supports the German VC market with both direct co-investments (this fund is promoted by Axis and the and indirect VC investments. Via its own privately EIF but it is managed by the EIF). The third and managed VC fund “Coparion”, KfW invests in currently main vehicle by which Axis can intervene in innovative German companies directly. Coparion is a the VC market is Fond-ICO Global, which was syndication fund which only invests in a company if a launched in March 2013 as the first public fund of funds private lead investor provides at least the same amount created in Spain. It has EUR 1.5 bn under Axis of capital on the same financial terms (“pari passu”). management and its main aim is to support the Further, KfW is invested in the High-Tech Start-up creation of new VC funds managed by private Fund (HTGF). It is a privately managed seed-fund set managers; Fond-ICO Global operates through public up as a public-private partnership between KfW, the tenders to private agents: after the last tender (the 7th) Federal Ministry for Economic Affairs and Energy, and it has so far allocated EUR 256 m to funds focused on established private companies. Via its promotion the first stages with a minimum settlement of program “ERP-Venture Capital Fund”, KfW invests in investment of EUR 793 m in Spain in said first stages. selected German and European venture capital funds focussed on start-up or early growth (second round) The British Business Bank’s main objectives are to financing. Via ERP-VCF, KfW acts as the cornerstone increase the supply of finance to smaller businesses in investor attracting private VC funds to the market. areas where markets do not work well and to help create a more diverse financial market for smaller CDP is committed to substantially increasing the pace businesses with greater choice of options and of development of the Italian VC market. For this providers. By the end of December 2015, the British reason, CDP currently plays a leading role in the Business Bank’s current venture capital programmes market mainly through Fondo Italiano di Investimento had supported 634 businesses with approximately GBP SGR SpA (FII). Since 2010, FII has invested in five VC 2.7 bn of equity funding. funds for a total commitment of about EUR 80 m, supporting nearly 60 companies. Under CDP’s

direction, FII launched two funds-of-funds (FoF), 17 The „National Plan for Industry 4.0“ was launched in September 2016 by namely FOF VC and FII Venture in 2014 and 2016 the Italian Government to promote technological change as a pillar of Italian industrial policy.

Page 24 General Part

Strengthening the VC market through the Capital 3. A revision of the regulatory framework, with a Markets Union specific focus on the European Venture Capital Funds Investments in Europe rely heavily on financing through (EuVECA)19 and the European Social Entrepreneurship the banking system. However, investments stagnated Fund (EuSEF)20 legislation. over the past years and many SMEs suffered from limited access to financing and worse financing As far as the first two measures are concerned, the conditions in several Member States. According to the Commission is currently at a preliminary stage: under estimates of the European Commission (EC), Euro- scrutiny is how national tax incentives for VC and pean SMEs collect five times less financing from capital business angels can foster investment in companies. In markets than their US counterparts; if European VC the second half of 2016, the EC is also expected to markets were as deep as the US market, more than publish a call for private sector asset managers to EUR 90 bn would have been available to finance express their interest in managing the fund-of-funds. companies from 2009 to 2014.18 The creation of a Pan-European fund-of-funds is particularly relevant and is designed to attract private In the attempt to complement bank financing with investors to the EU VC asset class and to overcome stronger and more integrated capital markets, the EC fragmentation, which is currently one of the main launched the “Capital Markets Union” (CMU) project. obstacles for the development of VC investment in One goal of the CMU is to enable capital to move more Europe21. freely within Europe, where liquidity is available but does not match investment opportunities perfectly. By Regarding the revision of the regulatory framework, in facilitating cross border-investments, more integrated July 2016 the EC presented a legislative proposal to capital markets would enable entrepreneurs to raise amend the EuVECA and EuSEF legislation. Both capital from a wider range of sources, regardless of regulations, creating a capital raising passport for their location. managers authorised to use these labels, were adopted and came into force in 2013. The initiative was In the belief that more integrated capital markets would an attempt to establish the appropriate regulatory lead to efficiency gains and support the EU’s ability to conditions for a successful EU VC market, making it fuel growth, the EC increased its efforts to establish a easier and more attractive for savers to invest in framework for a genuine single capital market in the unlisted SMEs. The results of this regulatory legislation EU. The “Action Plan on Building a Capital Markets are surely positive, although probably insufficient to Union” sets out a programme of 33 actions and related significantly revive the market (especially the one for measures, which aim to establish the building blocks of EuSEFs): since it came into force22, only 70 EuVECA an integrated capital market in the European Union by and just 4 EuSEF have been notified by ESMA 2019. Among these measures are some, which (European Securities and Market Authority)23. As a implicitly or explicitly refer to VC and which can thus consequence, on 30 September 2015, parallel to the play a key role in reviving VC markets in Europe. presentation of the “Action Plan on Building a Capital Markets Union”, the EC launched a public As part of the package of measures to support and consultation24 to ask whether, according to the stimulate Private Equity (PE) investments in general respondents, targeted changes to the two regulations and VC investments in particular, the European

Commission proposes several measures: 19 Regulation (EU) No. 345/2013 of the European Parliament and of the Council of 17 April 2013 on European venture capital funds, OJ L 115, 1. The development of a Pan-European VC fund-of- 25.4.2013, p.1. funds combining EU budgetary resources with greater 20 Regulation (EU) No. 346/2013 of the European Parliament and of the volumes of private capital, Council of 17 April 2013 on European social entrepreneurship funds, OJ L 115, 25.4.2013, p.18.

2. The promotion of best practices on tax incentives for 21 At EUR 60 m, the average European VC fund is only half the size of that in the US. Furthermore, 75 % of venture capital funds are smaller than VC to foster investment in companies. EUR 82 m.

22 22nd July 2013. 23 Official figures July 2016. 18 Commission communication to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions 24 Consultation Document (EC), Review of the European Venture Capital on Action Plan on Building a Capital Market Union, COM(2015) 468, Funds (EuVECA) and European Social Entrepreneurship Fund (EuSEF) 30.09.2015, p. 4. Regulations.

Page 25 Building Momentum in Venture Capital across Europe

could enhance the success of these legislative instruments: the Loan Guarantee Facility (LGF) and the initiatives. Equity Facility for Growth (EFG). Thanks to a planned budget of EUR 2.3 bn, it is estimated that the initiative Building on the outcome of the consultation, the EC will leverage up to EUR 25 bn in financing from proposes financial intermediaries. Although many of them will constitute PE funds, a relevant portion will be allocated • to extend the eligibility criteria for marketing and to VC. The two facilities are managed by the European managing EuVECA and EuSEF funds to include larger Investment Fund (EIF) in cooperation with financial operators (passports currently apply only to those intermediaries in EU countries. operators managing an overall portfolio of assets below EUR 500 m), As part of the Investment Plan for Europe, EIF launched a series of initiatives aimed at supporting • to expand EuVECA eligible assets to allow capital markets in general, including the VC segment. investment in small mid-caps and SMEs listed on SME Among these initiatives is the EIF-NPI Equity Platform, growth markets (this measure would not only translate a new collaborative project launched in 2016 under the into a larger number of companies benefitting from umbrella, but not limited to the scope of operations, of EuVECA investments but would also lead to a greater the SME Window Equity product of the European Fund diversification of risk) and for Strategic Investment (“EFSI SMEW Equity”). The platform promotes knowledge sharing and best • to abolish fees among Member States, simplifying practices among the EIFs and the NPIs in the EU the registration process. Member States. Its ultimate goal is to enhance access to funding for SMEs and Midcaps in their seed, early To sum up, the intention of the proposal is rather and growth phases; support integration of equity straightforward: widening both the spectrum of market markets; and guide EIF and NPIs in implementing participants and the range of eligible assets as well as equity investments, including EFSI-related activities. prohibiting cross-border fees could potentially increase The main characteristic of this platform is NPI the number of EuVECA and EuSEFs and, in turn, membership in the multilateral General Forum revive the VC market. dedicated to defining concrete opportunities for enhanced collaboration with the EIF or amongst the Reviving the European VC market by means of EU NPIs. financial instruments Among EU financial instruments channelling VC into 1.4 Recommendations for building momentum in SMEs, one of the most successful was the Competi- the venture capital markets in Europe tiveness and Innovation Framework Programme (CIP), European VC markets lack scale compared to those in which ran from 2007 to 2013. This mobilised more than the United States. The average size of funds in Europe EUR 2.3 bn in equity investments through its equity is smaller and returns are lower compared to both VC financing facility (the High Growth and Innovative SME funds in the United States and all other asset classes facility or GIF). Building on the positive experience of (see Box 2). This makes it more difficult for European the CIP, some new initiatives were launched: the VC funds to attract private investors. InnovFin SME Venture Capital within the Horizon 2020 programme together with the EU programme for the Bigger VC funds allow fund managers to realize competitiveness of SMEs (COSME). economies of scale with regard to costs and diversification, additionally allowing them to make InnovFin SME Venture Capital provides seed and larger (follow-on) investments. Thus, the problems in venture capital to early-stage research and innovation raising sufficient funds are, in turn, a cause of lower driven enterprises focusing on life sciences, ICT and performance – a vicious circle that must be broken. innovation in general. It operates through financial intermediaries including investment funds, venture It is important to stress that the current situation in the capital funds or vehicles that provide co-investment European VC industry is far different than it was during facilities for business angels or cooperate with the crisis of 2007/2008. That crisis resulted in a sharp business angels. decline in liquidity, which resulted in a lower supply of VC funding. Now, funding is more readily available in COSME, an EU-programme running from 2014 to general. The challenge is thus to increase the number 2020, aims to enhance access to loans and equity of investors allocating funding to the VC market and to financing for SMEs by means of two financial increase the size of those VC allocations.

Page 26 General Part

Since the beginning, National Promotional Institutions Introducing a more standardized regulatory VC (NPIs) have been important actors in European VC framework is a crucial step for reducing fragmen- markets, addressing market failure and helping the tation.27 This would also support the development of a markets to emerge (see country chapters for further common ecosystem of lawyers, accountants, advisors, detail). NPIs will continue to play a significant role in consultants or analysts who are experienced in VC. developing these markets. Also, the EU and national Ensuring that regulation does not put unnecessary governments are key players for ensuring that policy barriers in the way of institutional investors, such as and regulatory developments promote, rather than pension funds and insurance companies, which could hinder, VC markets across Europe. Considering the deter them from investing in VC would also be a step findings of this report, there are four areas where forward.28 further actions on national and EU levels are needed in order to build the necessary momentum in the Cross-border funds help to reduce fragmentation by European VC markets. generating experience and knowledge spillovers about different legal and regulatory schemes among fund Increase the supply of funds for VC investments investors, fund managers and investee companies. Encouraging the development of larger funds would Pan-European funds of funds open to public and enable EU VC funds to provide the multiple rounds of private investors would also fuel the supply of VC. The funding required for the full development of high growth EIF-NPI Equity Platform could be a basis for such firms. Larger funds will then be able to “stand ready to collaboration schemes. It would also facilitate VC firms write large cheques – fast”25 where appropriate, the to raise funds or young companies to expand abroad. same as US VC funds are able to do. Additionally, larger funds should be more attractive for institutional Perpetuating high-quality VC dealflow by increa- investors who have large minimum investment sizes. sing the demand for VC investment In some VC markets within the EU, VC firms want to Increasing a fund’s size can also enable better invest more but lack promising investment oppor- performance because fund size is empirically positively tunities. Facilitating cross-border investments is one correlated with fund performance. Despite the poor approach to overcoming this obstacle; however, average performance of EU VC funds, there are a inducing a permanent high-quality dealflow is also a number of high-performing funds. It is important to requirement. emphasise these in order to demonstrate the opportunities available to potential investors. Increasing the information available to small businesses about how to obtain equity financing would also Reducing fragmentation within European help. This could take many forms, from on-line VC markets information or working with business advisers through “It is likely that the [European VC] industry has not facilitating networking events where VC managers reached a critical mass, because of the relatively high could meet start-ups. level of fragmentation.”26 Due to diverging legal and regulatory regimes in different EU countries, VC funds In the United States, public sector demand was a key and LPs are likely to focus on their host countries when driver in the evolution of the VC industry, as it they invest. Promising investment opportunities abroad encouraged continuous development of new techno- may be missed, and fundraising from foreign investors logies, which in turn were the basis for new innovative impeded. This limits the ability of European VC funds to companies to commercialise them (see Box 3). Such a utilise economies of scale. virtuous circle could be put into operation by

Fragmentation of the EU VC market, therefore, • spending more on basic R&D and implementing an contributes to poor performance. Reducing the innovation system that provides companies with the fragmentation of VC markets in the EU and helping the complementary assets they need to translate new industry to reach a ‘critical mass’ may be the most knowledge into marketable innovative technology. The important steps for breaking through this vicious circle. United States demonstrated how such investments lay the foundation for new technologies and ideas and

25 See Brigl and Liechtenstein (2015). 27 See Tykvová et al. (2012).

26 See Kelly (2011). 28 See Kaya (2016).

Page 27 Building Momentum in Venture Capital across Europe

were crucial for a number of innovative start-ups which both channels need to be strengthened if a deeper and are now dominant global players. Many EU countries more efficient market is to develop. To increase the lag far behind in the share of R&D expenditures as a likelihood of IPOs, stock markets with sufficient liquidity percentage of GDP – they, in particular, need to raise to absorb IPOs from technology companies are their R&D investment levels. essential. Creating larger VC funds would indirectly improve the liquidity of the market, since larger funds • promoting spinoffs from universities and scientific enable firms to scale-up more and demonstrate their institutions that commercialise R&D results. This can potential ahead of an IPO. Regarding trade sales, unleash innovative market opportunities, especially in strategic industrial investors should be encouraged to countries where researchers at public universities have be more open for acquiring young, VC-backed legal difficulties starting their own companies. companies. In general, more publicity about successful exits would also help to raise awareness about • improving the opportunities for young innovative potential options for exit. companies to benefit from public procurement policy. This would help young innovative companies show the IPOs are supported by the assessments made by practicability of their products and also create growth financial analysts. Some stock markets currently lack opportunities for them. sufficient experts who are able to give an appropriate assessment of technology validation and market value • anchoring entrepreneurial issues in business for young VC-backed companies. This lack of expertise education programmes. This long-term approach could makes these companies’ stocks more volatile and this result in a larger number of entrepreneurs in the future. implied volatility can reduce their attractiveness for investors. • stimulating private donations to endowments at universities, which fund basic research or invest in This outline shows the challenges ahead for fostering start-ups. VC markets. Building momentum in VC in Europe will require activities on both the EU as well as the national Improve exit routes for VC investments level. The aim should be to strengthen national For a self-sustaining VC market, it is essential to have innovation systems, taking into account their individual not only a sufficient, high-quality potential dealflow, but differences, as well as to reduce fragmentation within also viable exit routes. Successful exits are usually Europe. accomplished via trade sale or IPO. Trade sale is the most widely used exit channel, while IPO is less frequent – even if it is the most profitable. However,

Page 28

2. Country Reports

2.1 France significant as that observed in other segments of the Alexandre Gazaniol and Baptiste Thornary (Bpifrance) private equity market (LBO particularly). After this decline, VC fundraising soared between 2010 and

2013. This rapid increase reflects the appearance of • Although the French VC market suffered during many new VC funds in the market, thanks both to the the economic crisis of 2008–2009, fundraising has emergence of new LPs (corporate investors and private significantly risen since and investments are individuals among others) and to the expansion of expected to increase in the coming years. existing LPs in the VC segment. According to Invest Europe, during the period 2010–2013, the average • In order to develop a viable ecosystem for VC number of funds raising money reached 34 funds per investors, Bpifrance has implemented a “fund of year, as opposed to 24 funds during the period fund” strategy over the last decades, which has 2007–2009. A large part of these new funds came from contributed to the professionalization of VC funds government agencies, in particular the French public and an increase in their size. Bpifrance also bank of investment (Bpifrance) (see Figure 18). manages direct funds, in order to cover industries or company development stages for which the supply Figure 19: Less French funds raise more capital of private funds is still insufficient. Fundraising in EUR m Number of funds

• Today, the French VC market is well structured 1,600 45 and competitive but still faces some important 1,400 40 challenges: financial performance of funds, 35 attractiveness for private / foreign investors, 1,200 30 consolidation of actors and emergence of larger 1,000 funds. 25 800 20 2.1.1 Development of the VC market 600 15 The French VC market emerged at the end of the 400 1990s, through public action. These actions aimed to 10 both develop private funds specialized in the VC 200 5 segment and to stimulate entrepreneurship, leading to 0 0 a progressive increase in fundraising and investment 2007 2008 2009 2010 2011 2012 2013 2014 2015 over the last two decades. Early stage Later stage venture Balanced Number of funds Source: Invest Europe / PEREP_Analytics Before the economic crisis, VC fundraising reached about EUR 1 bn in 2007 (Figure 19). Fundraising While French VC funds raised significant amounts of experienced a large decline in 2009, but not as money between 2010 and 2015 (EUR 7.1 bn in total

Figure 18: Amounts invested in French VC funds by investor type Fundraising in EUR m

900

800

700

600

500

400

300

200

100

0 Banks, insurance Corporate Family offices Fund of funds Government Other asset Private Academic Unclassified companies, investors agencies managers individuals institutions, pension funds Endowments and foundations

2010 2011 2012 2013 2014 2015 Source: Invest Europe / PEREP_Analytics

Page 31 Building Momentum in Venture Capital across Europe

over this period), their total investment was relatively Figure 21: Investments in French companies stable over the same period and amounted to Investments in EUR m Number of deals EUR 4.5 bn, suggesting that these funds have an 1,200 600 important “dry powder”. Therefore, their investments are expected to increase in the coming years. This 1,000 500 increase already appears in the statistics of the French association of private equity (AFIC), according to which 800 400 investments of French VC funds increased by 21 % in 29 2015, while the number of investees rose by 14 % . 600 300

Figure 20: Investments by French VC firms 400 200 Investments in EUR m Number of deals 200 100 1,200 600

0 0 1,000 500 2007 2008 2009 2010 2011 2012 2013 2014 2015

Seed Start-up Later stage venture Number of deals 800 400 Source: Invest Europe / PEREP_Analytics 600 300 2.1.2 Role of public institutions During the last 20 years, the French financial institution 400 200 “Caisse des Dépôts et Consignation”, and today Bpifrance, have played an important role in structuring 200 100 the VC industry. Through their intervention, these public institutions pursue multiple objectives: 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 • Dealing with market failures in SME finance markets, Seed Start-up Later stage venture Number of deals especially for innovative companies at the beginning of Source: Invest Europe / PEREP_Analytics their lives; VC funds (whether they are French or foreign30) have invested in nearly 400 French companies each year • Funding projects which do not generate high finan- since 2007 on average. All in all, French companies cial returns, but have high social value (e.g. reduction raised EUR 6.9 bn from VC funds between 2007 and of air pollution, benefits for heath); 2015. • Encouraging private / institutional investors to pursue Both in terms of number of companies and investment investments in the VC market through risk-sharing amounts, the main sectors invested in are computer mechanisms; and consumer electronics (26 % of invested amounts in 2015), life science (25.5 %) and communications • Taking direct action in some strategic and/or (16.5 %). All together, these three sectors roughly emerging economic sectors, with high potential of represented the same share of investments in 2007. added-value and competitiveness. Other main sectors invested in include consumer goods and retail (7 % of invested amounts in 2015), Bpifrance uses two different mechanisms to develop business and industrial products (6 %) and energy and the VC market. First, Bpifrance manages several environments (5.5 %) funds of funds: these funds invest in VC funds, which in turn invest in young companies. The goal of these funds is to attract private investors to VC funds by sharing the associated risks, and to help LPs to constitute funds with a sufficient size. Bpifrance always keeps a minority position in the invested funds and

29 Which differs from the 2015 figure displayed by Invest Europe as the enjoys the same rights as other investors (“pari perimeter can be slightly different, especially the coverage of small regional passu”). This leverage allows Bpifrance to reach many funds which can invest in a substantial number of firms each year. more companies than would be possible with a “direct” 30 But registered by the European VC association. investment strategy.

Page 32 Country Reports – France

More than 10 funds of funds were launched and have • The largest generalist fund (“Large venture”, with been managed by Bpifrance since the end of the EUR 600 m) was created to close the gap between the 1990s, mostly dedicated to VC funds (later stage start-up and growth phase fulfilling the vital equity venture and balanced stage). Two programs were needs of high growth start-ups, with the ability to exclusively dedicated to seed funds (only one is active accompany companies after they go public. Another today, see focus). Thus, government agencies are the large fund was created in order to invest in sizeable biggest investors in French VC funds. Bpifrance industrial projects with large corporates (fund “SPI”, invested almost EUR 2 bn in more than 130 VC funds EUR 700 m). (around 50 seed funds and 80 later stage and balanced funds), jointly with other private investors. 2.1.3 Specific challenges and needs The first challenge of the French VC market is to This “fund of fund” strategy has significantly contributed increase the size of VC funds. Companies have to the structuration, the professionalization and the essential equity requirements, especially in some strengthening of private equity in general, and the VC sectors such as biotechnology, and significant growth ecosystem in particular. In the VC segment, Bpifrance rates, so they need several rounds of funding over a invested in first time teams of LPs and first time funds. long period of time. That is why a fund’s ability to Except for retail funds which gather funding from reinvest in the successive rounds is crucial. The size of private individuals who fund and then benefit from a the VC funds is, as a consequence, decisive for the special tax credit, a large number of French VC funds development of the VC market and enables companies have raised money from Bpifrance. to be competitive in the global markets. Several VC actors have launched funds that are bigger than EUR 200 m and Bpifrance recently launched a EUR 600 m Box 4: Focus on the “Fonds national fund, able to make deals of up to EUR 10 m (“Large d’amorçage” Venture”, see above). In order to create a private VC industry in the seed segment, the French state decided to create a Figure 22: Performance of French VC funds since EUR 600 m “fund of fund” program, dedicated to origin financing seed VC funds, in 2011. This fund of fund, called “Fonds national d’amorçage” (FNA), is managed by Bpifrance and has the same objectives as a similar programme launched in 1999. 0.56 0.50 At the end of 2015, the fund had already invested 0.47 around EUR 400 m in 21 individual funds. The program has a significant leverage effect: on average, other investors contributed one euro for each euro invested by Bpifrance. The selected funds 0.50 0.53 0.54 invested in more than 230 companies, all in strategic economic sectors (health & life sciences, IT, environment, clean energy etc.). End 2013 End 2014 End 2015 Potential (RVPI) Realized (DVPI)

Bpifrance also manages “direct” funds, which Source: AFIC, Performance nette des acteurs français du capital- intervene in the VC segment. In 2014, new direct investissement à fin 2015. The figure displays the evolution of the investments consisted of about 50 companies and global multiple (Total Value to Paid-In – TVPI) of French VC funds EUR 150 m. These funds invest directly in companies since their inception. The TVPI ratio has wo components : the Distributed Value to Paid-In (DVPI) and the Residual Value to Paid-In to be able to respond in a more efficient and reactive (RVPI).DVPI is the ratio of distributed cashflows over cash flows paid way. In particular, they allow Bpifrance to cover some in to the fund, while the RVPI is the ratio of net asset value (at the emerging sectors for which the supply of VC funds is time of calculation) over cash flows paid in to the fund. still insufficient, and / or to compensate for the lack of The second challenge of the French VC market is private funds able to invest large amounts in the late to improve the financial performance of the stage phase: segment. This is one of the key issues of VC ecosystem development. According to the last available • The main sectoral funds are specialized in statistics, French VC funds (especially the recent ones) biotechnologies and life sciences (four funds), in IT performed better in 2015 than they did in previous (one fund) and in clean technologies (two funds);

Page 33 Building Momentum in Venture Capital across Europe

years, Over the 20-year span of the development of the The financial performance and attractiveness of French French VC market, VC firms gained experience and VC funds depend on various parameters: saw their performance increase.31 The VC industry has • Existence of promising projects and ability for LPs to demonstrated the ability to generate positive returns select excellent projects and to assist entrepreneurs in but more has to be done to attract private investors. In developing their businesses; particular, the performance of French VC funds is still inferior, on average, to the performance of British and • Long term investment: investors have to be patient US funds. and able to reinvest several times before they realise a return on their investment; Figure 23: Evolution of divestments in the French VC sector (number) • Capacity of secondary market to absorb companies Number of exit deals when VC funds sell their portfolio. 200 Over the past few years, the number of divestments 150 through public offerings or trade sales has increased, which is a positive and encouraging trend. Overall,

100 75 % of divestments correspond to trade sales, public offerings or sales to a private equity house.

50 2.1.4 Policy recommendations

0 The actions initiated by Bpifrance have already 2007 2008 2009 2010 2011 2012 2013 2014 2015 contributed to the professionalization of VC funds and Divestment by other means Divestment by write-off to the increase in their size. However, the creation of a Repayment of principal loans Repayment of silent partnerships viable ecosystem for VC is a learning process that will Sale to management Sale to financial institution take several decades and efforts must be made to Sale to another private equity house Divestment by public offering improve the financial performance of the VC segment Divestment by trade sale and its attractiveness for private investors. To this end, Source: Invest Europe / PEREP_Analytics Bpifrance will continue to adapt its “direct” and “fund of fund” strategies, according to the needs of the market. Figure 24: Evolution of divestments in the French VC sector (amounts) Divestments in EUR m

600

500

400

300

200

100

0 2007 2008 2009 2010 2011 2012 2013 2014 2015

Divestment by other means Divestment by write-off Repayment of principal loans Repayment of silent partnerships Sale to management Sale to financial institution Sale to another private equity house Divestment by public offering Divestment by trade sale Source: Invest Europe / PEREP_Analytics

31 See Bpifrance (2014).

Page 34

2.2 Germany VC market hard. Fundraising and investments slumped Georg Metzger and Vivien Lo (KfW) by 2003. They recovered by 2008, but still lagged far behind the peak.

• VC-investments of German investors peaked in VC firms raised more than EUR 1.2 bn in funds in both the year 2000 but promptly hit rock bottom in 2003. 2007 and 2008 (Figure 26). With the onset of the Investments recovered until 2008, however, they did worldwide financial crisis, fundraising again plunged to not reach half of their previous maximum. levels of EUR 400–600 m, only recovering to EUR 700–900 m recently. The more or less slow • Government intervention prevented the early- recovery which set in afterwards was interrupted in stage VC market from running dry in the mid-2000s 2011 when VC fundraising suddenly skyrocketed to nearly EUR 1.4 bn – about EUR one billion of it • In 2015 German companies received the most VC specifically for early-stage VC investments. A bigger of any year after 2008, however, the market fails to part of this one-time effect was due to the decision to provide bigger later-stage investments. endow the High-Tech Start-up Fund – a seed capital fund set up as a private public partnership – with fresh In 2015, a mere EUR 780 m in venture capital was capital (Figure 25). While fundraising with regard to invested in German companies – a small sum in amount of capital improved over the last few years, the relation to the country’s economic power. For number of funds that raised capital was in free fall. The comparison: in the United States, on average, about number fell from 39 in 2007 to 19 in 2009 and further to seven times more VC is invested in relation to gross 5 in 2012 where it has remained ever since. domestic product (see Figure 5). VC investment is also higher in European industrial nations such as the UK or The High-Tech Start-up Fund plays a crucial role in France. So, the German VC market has a great deal to providing seed capital for companies. In the aftermath catch up on. of the new economy crisis, new venture capital transactions in the very early stage had almost vanished by 2.2.1 Development of the VC market 2005. It was not until the High-Tech Start-up Fund and Traditionally, equity financing hardly played a role in the ERP Start-up Fund were launched by the German the German financial system. A significant market for Federal Government and KfW that the situation for over-the-counter equity emerged for the first time in the seed and start-up financing eased again. second half of the 1990s, in the course of the new economy boom. Fundraising and investments in German VC firms soared by the year 2000. However, the post-millennium new economy crisis hit the German

Figure 25: Government, corporates and private individuals fund the German VC market

Fundraising sources of German VC investors

EUR 1,230 m EUR 1,344 m EUR 414 m EUR 564 m EUR 1,377 m EUR 376 m EUR 574 m EUR 855 m EUR 736 m 12 % 7 % 12 % 18 % 15 % 10 % 9 % 31 % 18 % 43 % 11 % 48 % 9 % 32 % 10 % 13 % 81 % 14 % 11 % 61 % 17 % 15 % 7 % 44 % 25 % 40 % 39 % 52 % 21 % 26 % 14 % 7 % 13 % 7 % 7 % 7 % 7 % 8 % 2007 2008 2009 2010 2011 2012 2013 2014 2015

Banks Family offices Government agencies Unclassified Corporate investors Fund of funds Private individuals Other sources

Source: Invest Europe / PEREP_Analytics

Page 35 Building Momentum in Venture Capital across Europe

Figure 26: Fundraising of German VC firms Figure 27: Investments by German VC firms Fundraising in EUR m Number of funds Investments in EUR m Number of deals

1,600 40 1,200 1,200

1,400 35 1,000 1,000 1,200 30 800 800 1,000 25

800 20 600 600

600 15 400 400 400 10 200 200 200 5

0 0 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2007 2008 2009 2010 2011 2012 2013 2014 2015

Early stage Later stage venture Balanced Number of funds Seed Start-up Later stage venture Number of companies

Source: Invest Europe / PEREP_Analytics Source: Invest Europe / PEREP_Analytics Investments of German VC firms where less depressed to a level of EUR 600–700 m in the years 2009 to by the financial crisis than their fundraising. After 2012. Thus, during these years, German VC firms providing more than EUR 800 m in 2007 and EUR 1 bn invested more capital than German companies recei- in 2008 they reduced their investments to less than ved, meaning a net VC outflow abroad. In recent years EUR 800 m from 2009 to 2011 and further to less than this has changed once again. With investments of EUR 700 m from 2012 to 2014 (Figure 27). Most about EUR 700–800 m, the German market gained a recently, investments have recovered slightly. In 2015 net VC inflow. It is striking that this net inflow was about EUR 760 m of VC was invested by German VC attracted by a smaller number of companies than were firms. One reason for the reduction in investment was financed by German investors. So, only a few German that fewer companies were financed. In 2008, about companies benefited from this foreign VC investment. 1,150 companies were financed, a record high. Since 2012 their number has remained in the range of Figure 28: VC investments into German companies 800–900. Additionally, however, German VC firms Investments in EUR m Number of deals have reduced the average amount of capital that they 1,200 1,200 provide to companies. While an average start-up was backed with almost EUR 900,000 in 2007 and 2008, 1,000 1,000 the average company got only EUR 700,000–800,000 in the years that followed. In 2015 the average 800 800 investment rose to EUR 900,000 again.

600 600 The industry statistic includes investments of German investors abroad while neglecting investments of 400 400 foreign investors in Germany. This shortcoming is addressed by the market statistic. It reflects equity 200 200 investments in German firms and is, thus, more appropriate when it comes to assessing Germany’s 0 0 attractiveness for equity capital providers. 2007 2008 2009 2010 2011 2012 2013 2014 2015 Seed Start-up Later stage venture Number of companies

A comparison of industry and market statistics shows Source: Invest Europe / PEREP_Analytics that differences are small and ambiguous. In 2008, roughly 1.050 companies in Germany received about Three sectors have been the top recipients of VC since EUR 1.1 bn capital from foreign and domestic VC firms 2007: communications, life sciences, and computer & (Figure 28). So, German companies were attractive for consumer electronics. Companies in these sectors foreign investors that year because the market gained attract 60–70 % of all VC each year, with communi- a net VC inflow. This changed when the financial crisis cations and life sciences alternating as top recipient. occurred. Investments in German companies fell

Page 36 Country Reports – Germany

The economic and financial crisis in 2009 not only led EUR 50 m. It finances working capital, i.e. capital to a temporary slump in VC investments but also had a endowment to set up and run a small and innovative long lasting effect on the business climate in the enterprise, but no buy-out, restructuring or secondary German VC market. This is shown by the German transactions. The initial seed investment of HTGF takes Private Equity Barometer, a joint survey conducted by place as a convertible loan of up to EUR 600,000. For KfW and BVK (Figure 29). It was not until 2015 that the follow on investments, at least one further private business climate fully recovered from the drastic slump investor is needed (private investor test) with which up in sentiment and reached a new peak. The good news to EUR 1.4 m can be invested. HTGF is set up as a is that the investment activity of German VC investors public private partnership with the Federal Ministry for is more stable than their sentiment. Economic Affairs and Energy, KfW and 17 established private companies as its shareholders. HTGF is notified Figure 29: Development of business climate and by the EU Commission. demand in German VC market Balance points, max: 100, min: -100 ERP Start-up Fund / Coparion ERP-SF, administered by KfW on behalf of the Federal 100 Ministry for Economic Affairs and Energy, supplied VC

80 to technology oriented companies for R&D or market entry financing. However, ERP-SF operated passively,

60 i.e. at the request of a lead-investor whose investment was mirrored pari passu. In order to strengthen its 40 opportunities, this instrument was reorganized and launched anew as the co-investment fund “Coparion” in 20 March 2016. As a separate company led by an experienced management team, Coparion will, how- 0 ever, be able to act in a more market-oriented way,

-20 faster and more flexibly than the ERP-SF was able to '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 react. It invests directly in innovative companies and Quarterly VC business cllimate Long-term average young technology companies. However, the fund Assessment of VC demand Long-term average adheres to the proven principle of only investing in a Note: The indicators reflect the weighted balances between ‘good’ company if a private lead investor provides at least the and ‘bad’ reports by participating BVK members. same amount of capital on the same financial terms. Source: German Private Equity Barometer. With a volume of EUR 225 m, Coparion is the largest VC fund in Germany. Through cooperation with all the 2.2.2 Role of the national development bank market players, Coparion provides important stimulus After the new economy crisis, when the VC market in for the further development of the venture capital Germany was down, it became clear just how important market in Germany and mobilises significant additional the public supply of VC is for the survival of the private capital for German companies. German VC market. When seed capital investments almost vanished, public authorities stepped into the ERP-Venture Capital Fund breach for private investors to maintain minimum VC Since April 2015 KfW has also started to help meet the availability for companies: the High-Tech Start-up Fund shortfall in follow-on and expansion financing available (HTGF) and the ERP Start-up Fund (ERP-SF) were to young innovative technology companies. It is just established. Providing public venture capital is parti- businesses like these – high-tech companies working cularly important, precisely because it can mobilize VC in the areas of clean technology, life sciences and from private equity providers (crowding-in). Founders of med-tech, as well as e-commerce platforms and other high-technology enterprises, in particular, can be "digital" companies – which need a substantial amount motivated by the prospect of obtaining VC. More of capital to enable them to develop and grow. To companies are founded when the supply of VC im- support them in this process, KfW, in collaboration with proves. A public supply of VC is therefore crucial to the the Federal Ministry for Economic Affairs and Energy development of a sustainable start-up scene. has introduced a new promotional instrument onto the market, the ERP-Venture Capital Fund (ERP-VCF). High-Tech Start-up Fund KfW is using this instrument to invest in young German HTGF focuses on young high tech companies which technology companies indirectly via selected German are still in their seed-phase (up to one year after and European venture capital funds focussed on start- foundation) having maximum annual turnover of up to up or early growth (second round) financing. ERP-VCF

Page 37 Building Momentum in Venture Capital across Europe

will invest up to EUR 400 m in first closings and in first Figure 30: Development of exit activity time funds over the next five years. Acting as the Divestments in EUR m Number of exit deals cornerstone investor, a total of EUR 2 bn of private VC 600 600 is going to be leveraged, further improving the development of the VC market. Endowing existing funds with 500 500 more capital will enable bigger deals to be made.

400 400 2.2.3 Specific challenges and needs

Equity capital plays only a secondary role in the broad 300 300 SME sector in Germany. The "business survey" conducted jointly by KfW Research and industry 200 200 associations shows that it is much less important than internal financing, bank loans, supplier loans and 100 100 leasing. 0 0 Venture capital seekers are young, innovative and 2007 2008 2009 2010 2011 2012 2013 2014 2015 technology-oriented Amount at costs Number of exit deals The more innovative and the younger an enterprise, Source: Invest Europe / PEREP_Analytics the more important venture capital is. Debt capital providers often consider the absence of a company It is difficult to say which exit route is most important in history, insufficient collateral and the high uncertainty of Germany because the structure of exit deals in amount success of the innovations of young innovative at cost and number varies (Figure 30). On the one companies to be unsurmountable information deficits. hand, from 2007–2015 more than half of all exit deals Accordingly, VC is more important for these types of (51 %) were repayment of silent partnerships, while the companies. While only 8 % of all enterprises regard amount at costs was only 12 %. On the other hand, a equity capital as important, this proportion is 13 % third of the exit amount at costs was divested via trade among research-intensive and younger enterprises. sales, (34 %) which correspond to only 9 % of all exit This is also reflected in the external financing of deals. Write-offs were nearly balanced accounting for companies. The findings of the KfW/ZEW Start-up 28 % of exit deals and for 30 % of exit amount at costs. Panel show that of the total amount of external financing provided to start-ups only 5 % is equity This pattern is a result of the financing activity of the so capital. This share is 13 % in high-tech manufacturing called Mittelständische Beteiligungsgesellschaften companies and as high as 35 % in high-tech companies (MBGs) which are a peculiarity of the German private in the services sector. equity market. These financial institutions were founded in the 1970’s by the industry as self-help VC providers keep an eye on exit channels organisations. Shareholders of the MBGs are There is demand for venture capital in Germany chambers, trade associations of all sectors, credit (Figure 29). Several reasons for the short supply are institutions, insurers and the development banks of the being discussed, including not only the legal and tax federal states. The aim of the MBGs is to strengthen environment, but primarily the exit prospects. After all, the equity capital basis of the companies they finance. the incentive to invest is all the higher, the better the The most common way by which they do this is to chances of achieving a high return when exiting an contract silent partnerships in the amount of EUR investment. 300,000–500,000. The pattern of exit routes shown in Figure 31 is thus not merely a map of how investors Exit activity developed ambiguously in Germany decide to exit a partnership, it actually depends heavily between 2007 and 2015. While the number of exit on the instruments they used to invest: a silent deals peaked in 2010, the amount of exit at cost partnership has to be repaid or written-off and is not to remained at a level of EUR 400–500 m for the most be exited via trade sale, buy-back or IPO. part, showing drops to around EUR 350 m in 2007, 2010 and 2013 (Figure 30). The difference between the levels of exits in amount and number was particularly large in 2010. There appear to have been a significant number of divestments of minor participations that year.

Page 38 Country Reports – Germany

Figure 31: Exits by sale of silent partnerships Although IPOs are the most profitable exit channel, dominate and write-offs account for 80 % of deals they are not suitable for every start-up because of the Exit routes in per cent, average 2007–2015 substantial effort they require. The most important exit channel for equity participations is thus trade sales, i.e. the sale of a participation in the enterprise to a strategic 14 investor, for example an industrial firm from the same 7 9 3 2 3 0 industry sector. The "secondaries" industry, which 34 7 involves selling equity on to another private equity firm, 28 also plays a significant role.

12 51 US IPO Market livelier 1 In the United States, IPOs of companies are an established element of the stock market landscape. 30 During the financial crisis, the US IPO market slumped Divestment by trade sale Divestment on flotation (IPO) temporarily but recovered quickly. In 2014 alone, some Divestment by write-off Repayment of silent partnerships 120 VC-financed enterprises went public there while in Sale to another private equity house Sale to management ("buy-back") Germany there were only a handful (see Figure 32). Divestment by other means

Source: Invest Europe / PEREP_Analytics Having a stock market which is able to absorb large- volume exits, VC investors may be more willing to However, real equity investors can achieve the best make larger investments. The more lively IPO activity returns by means of a successful initial public offering can thus be a reason why deal sizes in the US VC (IPO). The problem in Germany is that, after the New market are, on average, seven times higher than Economy bubble burst and the New Market collapsed investments in German companies (remember Fi- at the beginning of the millennium, this exit channel gure 7). US companies are fuelled with nine times was virtually blocked. The German IPO market has not more VC at the seed stage, meaning that they can do (yet) recovered from the downturn. Even before the their proof-of-concept or even proof-of-market faster New Market was established, the number of IPOs was than their German rivals (Figure 33). At the start-up many times higher than it is today. Besides, it will likely stage they are backed by five times more VC, which is take more time for the recently improved climate for why they can unfold their potential to a higher degree. IPOs in Germany to translate into a higher number of When it comes to expansion in the later stage, US IPOs of VC-financed enterprises. companies are pushed with seven times more VC so

Figure 32: Post-crisis IPOs in Germany still few, while IPOs in the US recovered fast Number of IPOs Germany USA 207

159 157 159 157

34 117 25 91 93 81

15 16 12 10 41 8 8 6 21 2 1

'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 15

IPOs Private Equity financed companies IPOs VC financed companies IPOs Buy-out financed companies Other IPOs Other IPOs Note: Since 2007 statistics show the categories later-stage venture capital and growth capital but no longer expansion capital. We added up later-stage venture capital and growth capital in order to perpetuate the expansion capital time series from 2007 onwards.

Source: BVK (2016) for Germany, Ritter (2016) for the USA.

Page 39 Building Momentum in Venture Capital across Europe

they can reach a high market penetration very quickly The classic VC financing process, which involves and win market leadership quite easy. several rounds of financing in which the amounts increase every time a milestone is reached, is hardly Figure 33: US companies fuelled with significantly suitable for this type of strategy. Rather, what is more VC – at every development stage important after the provision of relatively low-volume Mean deal size* in EUR m, average 2007–2015 start-up financing is large-volume follow-up financing to enable growth and market penetration. The venture capital scene in the United States has adapted to these special needs of companies in the digital economy. This development should be followed in Germany as well.

2.2.4 Policy recommendations Overall, a gap can be observed in the supply of venture capital in Germany, particularly in follow-up financing for enterprises that are in the start-up and growth phases. This is addressed by the reorganized KfW equity financing instruments. Beyond that, the options for exiting deals through IPOs have not reached their potential either. Experts have already discussed Note: The average deal size is calculated as the relation of VC whether start-up enterprises should undergo specific investments and number of deals. The values for Germany include training to prepare them for going public, as is the case financings by Mittelständische Beteiligungsgesellschaften which in the UK. Some actors in the private equity market provide a large number of smaller financings. US VC investment values were converted into euro based on annual average exchange have also suggested reintroducing a specific segment rates. of the stock exchange in order to generate greater awareness and visibility among investors. Recently Source: BVK, PricewaterhouseCoopers / National Venture Capital Association MoneyTree™ Report Q2 2016, ECB, own calculations. Deutsche Börse took steps to address these issues. In 2015 it started a networking platform on which young, Growth financing is becoming more important in growth oriented companies and international investors the digital economy could be brought together in order to initiate funding The big-ticket items being made available to US 32 rounds and to organise training events. Based on this companies appear to be a crucial advantage, platform it recently started a service which seeks to particularly in the global growth environment of the directly match the preferences of participating investors digital economy. The business models of digital and companies in order to make the funding process companies are fundamentally different from those of 33 more efficient. Furthermore, the latest news is that classic technology companies. In many cases, they Deutsche Börse will introduce a new exchange need only a relatively small amount of start-up segment for smaller and medium-sized enterprises in financing (seed capital) in order to develop a "digital" 34 March 2017. An index representing the companies business idea. So they face lower hurdles to entering listed there is being developed. Something is the market. happening in the German VC market –it appears to be going in the right direction. If such companies want to remain globally competitive, however, they will quickly have to attract many customers (increase market share) and establish a lead in brand recognition. In other words, what is crucial to them is not the high cost of developing a technically mature product prototype, but the speed at which they introduce it into the market.

32 See Deutsche Börse press release „Deutsche Börse launches Venture Network to fund young growth companies“, 11 June 2015.

33 See Deutsche Börse press release „Deutsche Börse Venture Network launches service for financing rounds“, 6 September 2016.

34 See Deutsche Börse press release „New SME-segment to facilitate access to growth capital for enterprises“, 21 November 2016.

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2.3 Italy externalities for SMEs and innovation. Firstly, a clear, Claudio Bruno and Gino del Bufalo (CDP) definite, stable regulatory and fiscal framework is needed. Secondly, the participation of all types of

investors, particularly pension funds and corporates • An international comparison shows that the Italian needs to be enhanced. Lastly, it is of utmost VC market still lags behind. Nevertheless, while importance to professionalize the VC market in Italy by investment in Italian start-ups has not recovered yet, investing in funds with adequate dimensions and fundraising has improved in the last three years. governance inspired by international best practices.

• International investors’ appetite for Italian assets 2.3.1 Development of the VC market is growing. However, the availability of investment Since its origin, the Italian VC market has always vehicles and / or securities is still inadequate. struggled to reach high volumes. In 1986, the Italian Private Equity and Venture Capital Association (AIFI) • As the national promotional institution, CDP is was founded. Nonetheless, only in the second half of committed to reviving and boosting the development the 1990s did a valuable VC market emerge, reaching of the Italian VC market, among other things, by its peak at the beginning of the new millennium. Then, structuring suitable financial instruments that can following the burst of the New Economy bubble, the appropriately match investors demand. Italian VC segment declined steeply until 2005. After a recovery in 2006/2007, the market continued to drop Playing a marginal role in the Italian financial system, (Figure 34). the Italian venture capital (VC) market still lags behind if compared with other markets. Figure 34: Fundraising of Italian VC firms Fundraising in EUR m The small size of the Italian market is probably the result of simultaneously concurring factors, both on the 250 demand and on the supply side. As far as demand is concerned, the negative economic environment led to 200 an actual decrease in the number of start-ups in the last few years. This, coupled with the Italian corporate 150 culture, traditionally made up of family-run businesses biased against external equity investors, as well as marked regional imbalances, depressed demand even 100 further. On the supply side, limited exit-strategy options have an adverse effect on the Italian VC market’s 50 appeal. The contribution of the public sector can therefore become a key factor in developing the 0 market. 2007 2008 2009 2010 2011 2012 2013 2014 2015 Early stage Later stage venture Balanced In an attempt to fill the gap between the demand for Source: Invest Europe / PEREP_Analytics and the supply of VC funds, Cassa Depositi e Prestiti S.p.A. (CDP) entered the still underdeveloped Italian In 2015, total VC fundraising reached EUR 44.5 m35, VC market in 2010, through “Fondo Italiano di one fifth of the level achieved in 2014 and the lowest Investimento SGR” (FII), one of its core equity level in the three years prior to that. Although investments. Moreover, with the new Business Plan fundraising for early-stage focused funds decreased 2016–2020, CDP emphasizes its strategic goal of more than proportionately by 82 % to EUR 29.5 m, it augmenting its current role as Italy’s leading VC still represented more than two thirds of the total operator, thus encouraging the creation of start-ups market in 2015. and intensifying its support for innovation and the development of enterprises. Volumes remain relatively low compared to those of other European VC markets. Major efforts are needed Although the modest size of the Italian VC market in order to reallocate a larger part of the investments of could be seen as a huge problem, it also clearly

represents an important growth opportunity for the 35 This amount refers to funds raised by Italian advisory teams that manage Italian economy with significant and positive the funds, regardless of the funds ‘origin.

Page 41 Building Momentum in Venture Capital across Europe

banks, corporate investors, funds of funds and VC activity (49 %), immediately followed by start-up insurance companies towards the Italian VC market. investments (47 %), which involve the largest number Furthermore, pension funds, which have historically of companies (26 out of 39). Seed investments almost played a marginal role in the Italian VC sector, should halved with respect to the levels reached in 2014 and be encouraged to actively participate in the market. just 7 companies were venture backed at this stage of their development. The lack of interest in this segment As far as VC investments are concerned, both industry is probably symptomatic of a modest level of willing- and market statistics should be considered. In fact, ness and propensity to invest in companies from the industry statistics, namely investments made by Italian very first stage of their life-cycle, before the business VC firms regardless of the location of the portfolio has actually reached the start-up phase. Increasing company, are a proxy for Italian investors’ attitude investment at this stage is key. towards the whole VC market. On the other hand, market statistics, investments in Italian companies Figure 36: VC investments into Italian companies regardless of the location of the VC firm, are a key Investments in EUR m Number of deals factor in assessing the attractiveness of Italian 150 90 companies to equity capital providers.

125 75 Industry statistics indicate that Italian investors allocated roughly EUR 33 m in domestic and foreign 100 60 markets, broadly in line with VC investments in 2014.

This implies that Italian investors are still showing a 75 45 rather low level of interest in the VC market.

50 30 Figure 35: Investments by Italian VC firms Investments in EUR m Number of deals 25 15

150 90 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 125 75 Seed Start-up Later stage venture Number of deals

100 60 Source: Invest Europe / PEREP_Analytics The analysis of the sectoral distribution of VC 75 45 investments shows that, in 2015, the financial services sector was the main target attracting over a third (37 %) 50 30 of the total VC investments. Other relevant sectors were: life sciences (27 %), communications (13 %) and 25 15 consumer goods and retail (7 %). In terms of number of companies, the sectors attracting most of the 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 investments were communications (12), consumer goods and retail (10) and life sciences (8). Seed Start-up Later stage venture Number of deals Source: Invest Europe / PEREP_Analytics Looking at Figure 35 and Figure 36 it can be noticed Market statistics provide relevant information about the that industry statistics and market statistics broadly real appetite that investors from all over the world have follow the same trend over the years. An in-depth look for Italian start-ups in search of capital. In 2015, Italian reveals that investments calculated by market statistics companies attracted investments of roughly one twelfth were constantly higher, meaning that foreign investors’ of the European average in relation to GDP. The total appetite for Italian companies does exist. A friendlier amount of VC investment in Italian companies reached environment for foreign VC investors would definitely EUR 46 m and 39 companies were venture-backed contribute to significant market expansion. that year. Despite a 40 % increase in investment with respect to The total amount of VC investment in Italian companies 2014, data for Italy is particularly worrying for two main in 2015 was almost 40 % higher than total investment in reasons: 2014, but it is still the second lowest amount in 8 years. Later stage investments roughly constitute half of

Page 42 Country Reports – Italy

1. Italy started from relatively low investment levels Capital” (FoF VC) started their activity on 1 September (significantly lower than those of its European peers) 2014, with an initial size of EUR 250 m and EUR 50 m respectively; both commitments were entirely 2. The Italian economy is currently characterized by a subscribed by CDP38. Thanks to this unprecedented long-standing contraction of bank credit36 which has contribution, CDP is now the largest domestic disproportionate effects on SMEs’ financing conditions VC operator. in the bank-oriented Italian financial system. Although VC financing has a substantially different scope than To date39, the FoF VC has already committed bank lending, a contraction of the latter makes VC EUR 15 m in Innogest Capital II40, a VC fund operating financing a precious alternative to traditional channels. at all venture stages; EUR 10 m in Sofinnova Capital Hence, a small dimension of this market can have VIII41, a fund particularly focused on red biotech; particularly severe consequences. In such a scenario, EUR 3 m in Oltre II, a fund focused on impact the contribution of the public sector can become a key investing; and EUR 17 m in Barcamper Ventures, a factor. fund operating in seed capital. Moreover, the Technical Committee of the Fund backed an additional 2.3.2 Role of public financial institutions investment of EUR 17 m, subsequently endorsed by By partially filling the gap between the demand for and SGR's Board of Directors. The subscription of this the supply of VC funds, hence addressing a long- investment is expected to be completed during the standing market failure, CDP plays a leading role in the second half of 2016. Thanks to this decision of the Italian VC market. board, FII’s commitment to VC in Italy is now expected to rise to an overall sum of EUR 142 m. In 2010, together with the Italian Ministry of Treasury and Finance, the Italian Industrial Association, the By attracting private finance to invest together with FII Italian Banking Association and other "Sponsor in VC funds, FoF VC acts as anchor investor with the Banks”37, CDP launched “Fondo Italiano di final intention of helping funds to achieve a critical Investimento SGR” (FII), a company which, through mass. Through the FoF VC, which now amounts to managed funds, aims to support small and medium- EUR 80 m and is expected to achieve EUR 150 m in sized Italian companies at every stage of their life the near future, FII aims at leveraging up to cycle. In November 2010, the Fund completed its first EUR 500–600 m. This seems rather relevant if consi- closing, in the amount of EUR 1.2 bn, and CDP dering that yearly total market investments were, on participated, contributing EUR 250 m. Since 2010, FII average, no more than EUR 80m over the past seven has taken part in the financing of 21 private equity and years. VC funds for a total commitment of about EUR 440 m, of which EUR 80 m dedicated to venture capital Moreover, on 5 April 2016, FII approved the partial operations supporting nearly 60 companies. proportional demerger of “Fondo Italiano d’Investimento” into three different investment vehicles, However, it was not until 2014, when the situation one of which, Fondo Italiano d’Investimento FII became particularly critical due to a persistent credit Venture, with an initial capital endowment of crunch, that CDP became a pivotal operator in the EUR 91 m, is exclusively focused on indirect invest- Italian VC market. As a matter of fact, in 2014, ment in other venture capital funds or vehicles. This following a period which had witnessed low levels of last operation further confirms FII’s increasing interest fundraising, CDP decided to massively intervene in the in the VC market. VC market. On its initiative, two new funds-of-funds (FoF) were launched within FII, one for the venture capital market and the other for the private debt market

for Italian companies. The ”Fund of Funds Private 38 The ”FoF Private Debt” focuses on funds active in the private debt market Debt” (FoF PD) and the ”Fund of Funds Venture (mini-bond and other debt instruments) to support Italian SMEs; the ”FoF Venture Capital” focuses on start-ups and growth capital funds investing in high-tech companies.

39 5 September 2016. 36 The total amount of new loans granted in January 2016 to non-financial firms was EUR 32.8 bn, EUR 2.3 bn less than loans granted in January 2015 40 The overall commitments in Innogest Capital II amounted to EUR 64.6 m (Source: Bank of Italy). (data at 31 December 2015).

37 UniCredit Group SpA, Intesa Sanpaolo SpA, Banca Monte dei Paschi di 41 The overall commitments in Sofinnova Capital VIII amounted to Siena SpA. EUR 298.6 m (data at 31t December 2015).

Page 43 Building Momentum in Venture Capital across Europe

Lastly, with the launch of the new Business Plan led to a factual decrease in the number of start-ups in 2016–2020, CDP confirmed its intention to consolidate the last few years. its role as a leading Italian VC operator, encouraging the creation of start-ups and intensifying its support for Furthermore, the marked regional imbalances innovation and the development of enterprises. CDP’s characterizing the Italian scenario, in part, account for ambition is to be present at every stage of the the gap that exists between the Italian VC market and development of new enterprises, by increasing the the VC markets in other countries. Regional current commitment in support of existing VC funds imbalances in Italy are indeed so pronounced that, (i.e. FoF VC) and launching relevant initiatives in the according to data provided by the Italian Association for technology transfer (ITAtech Platform) and accelerator Private Equity and Venture Capital (AIFI), in 2015 the (AccelerateIT) industries under the umbrella of the number of private equity and VC investments in the “Industry 4.0 Plan”42. ITAtech is an investment platform North of the country was more than 4 times the number with the aim of catalysing and accelerating the of investments registered in the Centre and almost commercialisation of Intellectual Property with 8 times larger than the number of investments in the technological content. The platform, which will be co- South of the country. invested by CDP and EIF and possibly benefit from the resources of the Juncker Plan, is expected to crowd-in Another demand-related barrier hindering the other private investors. AccelerateIT is a business expansion of the market in Italy is an actual decrease acceleration programme providing capital, mentorships in the number of new firms in the country during the and training to start-ups. The programme will gather period 2011–201443. Over this period, the challenging the contributions, financial and non-financial, of several Italian economic environment pushed new partners such as EIF, public institutions, private actors entrepreneurs to settle in more fertile countries with a and business angels. friendlier business environment. There is in fact clear evidence of an increasing number of start-ups that from To conclude, public initiatives are surely needed in 2011 to 2014 “migrated” to the UK, where more order to partially reduce the gap between the demand developed capital markets exist44. In this regard, 2015 for and the supply of VC funds and to address, to a appears to be signalling a reversal of fortune as for the certain extent, the existing market failure in the VC first time after 4 years, an increase in the number of scene. Although such initiatives are certainly to be new firms was registered, potentially driven by an welcomed, they cannot represent a long-standing and improvement in the economic conditions of the country definitive solution to the problem. This report intends to and a friendlier regulatory environment for new identify some possible solutions or policy businesses. Since 2012, Italy has indeed endowed recommendations to mitigate the problem. In order to itself with a powerful arsenal of legislation aimed at do that, the main challenges characterizing the Italian strengthening the national start-up ecosystem. The VC market are presented in the next paragraph. tangible improvements were recognized: Italy ranked second in Europe in “The 2016 Start-up Nation 2.3.3 Specific challenges and needs Scoreboard”, which measures a country’s political According to market data, the VC market is smaller and determination to provide policy support to start-ups45. less developed in Italy than it is in other European countries. The interpretation is that a unique On the supply side, as is the case with the demand concurrence of causes, both on the demand and side, cultural factors are particularly relevant. Italian supply side, contributed to the limited expansion of the investors typically have a longstanding risk aversion, Italian market. mainly driven by their lack of experience in dealing with capital markets and equity investments. Italian Demand side factors are influenced by both the cultural investors have, in fact, historically invested in Italian context and the economic situation. Indeed, a large sovereign debt bonds which have typically rewarded number of small Italian companies are family-owned them quite generously. and do not typically appreciate external interference in their business and the negative economic environment 43 Cerved (2016). Osservatorio sulla imprenditoria in Italia #2.

44 The UK market’s attractiveness is not only driven by the copious number of 42 The „National Plan for Industry 4.0“ was launched in September 2016 by investments, but also by the ease with which a company can be established the Italian Government to promote technological change as a pillar of Italian and managed as well as by more favorable taxation. industrial policy. By means of both debt and equity instruments, CDP will play a key role in this plan. 45 European Digital Forum (2016). The 2016 Startup Nation Scoreboard.

Page 44 Country Reports – Italy

Among supply side factors, exit prospects are average of 5 IPOs per year took place in the period particularly relevant as they deeply affect a national 2008–2012. However, public offerings recovered in VC market’s appeal. A dynamic and bustling market, 2014 and 2015 with 26 and 27 IPOs respectively. historically characterized by a large number of divestments, is certainly more attractive than a static The above considerations are indicative and simplified, one with less opportunity to divest. Consequently, a but the take-home concept is that if exit values are so small number of divestments is often associated with a low, Italian VC firms will consequently keep their low level of investment. As a matter of fact, just valuations low in order to achieve adequate returns and 3 venture-backed companies, representing a former shareholders will therefore be unlikely to sell part of equity investment of EUR 15.4 m, were divested in Italy their businesses to VC investors. in 2015 (Figure 37). Figure 38: IPOs at Borsa Italiana Historically, trade sale, namely the sale of company Number of IPOs shares, and sale of listed equity are quite common in 35 the Italian scenario compared to other exit routes. By contrast, no company has been divested through IPO 30 since 2010. 25 A successful initial public offering (IPO), a favourable 20 sale of a company’s shares to the public for the first time by listing the company on the stock exchange, is 15 arguably the most remunerative exit strategy for an investor. The absence of any venture backed IPO in 10 the last 5 years and the fact that only 3 venture-backed 5 companies have been divested through an IPO in the last 8 years is a clear sign of the Italian VC market’s 0 current struggle. 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 MTA AIM Italia - MAC MIV Figure 37: VC divestments by exit route Note: MTA is the Italian Market dedicated to medium and large-size companies, AIM Italia is the market specifically created for small and Divestments in EUR m Number of exit deals medium-size Italian enterprises. MIV is Borsa Italiana's regulated 80 16 market created with the scope to provide capital, liquidity and visibility to investment vehicles. 70 14 Source: Borsa Italiana 60 12

50 10 To sum up, there is no empirical evidence indicating whether the problem is supply or demand driven. On 40 8 the contrary, it is very likely that demand and supply 30 6 factors feed each other in a vicious circle. In order to 20 4 develop the Italian VC market, it is therefore key to 10 2 identify the most efficient ways of matching supply and

0 0 demand. The desirable outcome is that the vicious 2007 2008 2009 2010 2011 2012 2013 2014 2015 circle turns into a virtuous self-reinforcing circle in

Divestment by trade sale Divestment by public offering which demand drives supply and vice versa with Sale to another private equity house Divestment by other means positive externalities for SMEs and innovation. Number of exit deals Note: Divestment by other means includes: repayment of silent To conclude, the low level of divestment represents the partnerships, repayment of principal loans, write-off, sale to financial major obstacle on the supply side. However, looking at institutions, sale to management, etc. Figure 34, it appears evident that fundraising in the last Source: Invest Europe / PEREP_Analytics three years was relatively abundant. It is likely that the 46 low level of investments in the last three years was a Overall IPO activity reached its peak in 2007 with 29 result of close-to-zero fundraising in 2010–2012. The IPOs. After the crisis, the Italian equity market suffered effects of the increased level of fundraising in as a result of significantly weak IPO activity; an 2013–2015 on investments will probably materialise 46 Regardless of whether the company is venture backed. from 2016 onward.

Page 45 Building Momentum in Venture Capital across Europe

2.3.4 Policy recommendations flexible procedure for listing and protecting investors, Although the modest size of the Italian VC market thanks to an efficient regulatory system that meets the could be seen as a huge problem, it also clearly needs of small businesses and specialized investors. A represents an important growth opportunity for the dynamic and bustling market can surely increase the Italian economy with significant and positive interest of VC funds in investing in Italian companies. externalities for SMEs and innovation. The latter is particularly true in the current low interest rate scenario Thirdly, it is key to enhance the participation of all types which can boost VC investments. Revitalizing the VC of investors in fundraising for VC funds. Pension funds market can be a blessing for the Italian economy and other categories –such as big corporations – have overall. In this respect, in our opinion, some important historically played a marginal role, not only in Italy but steps must be taken. throughout Europe. On the contrary, in the US, these types of investors are particularly important and make Firstly, creating a clear, definite, stable regulatory and up a large share of the market. Policy measures, such fiscal framework for domestic and foreign operators as the current one under scrutiny by the government, and strengthening the alignment of the regulation to that call for tax relief for companies investing in start- that of the main European countries are surely two key ups younger than 5 years of age, are welcome. In preconditions for the development of the market. In 2016, four big international corporations (Amazon, recent years, policy makers in Italy have enabled the Intel, Microsoft and Cisco) invested in the VC fund adoption of regulatory and fiscal measures to “Italian Venture I”. That shows how Italy continues to encourage the creation of innovative start-ups, in order gain the confidence of international investors. Hence, to promote sustainable growth, technological facilitating international investors’ access to the Italian development and youth employment. Innovative start- VC market is a critical success factor for its ups and SMEs can benefit from two important development. measures in favour of technological innovation: (i) a fiscal benefit of up to 50 % for investments in R&D, Dealing with intense competition and high valuations in and (ii) the so-called “Patent Box47” which permits their home markets, foreign investors are indeed eager companies to exclude 50 % of income derived from the to diversify their investment portfolio. UK venture commercial use of intangible assets (copyrights, capitalists, in particular, have demonstrated their industrial patents, and commercial brands) from interest in the Italian market and a more massive taxation. Political and policy determination in creating a involvement by these operators should be advocated. friendlier business and innovation ecosystem is surely to be appreciated and further encouraged. Lastly, the number of operators is still too small. Scaling-up business angels and other small operators Secondly, looking at Figure 38, it becomes clear that to VC operators with critical mass can be an the overwhelming majority of IPOs over the last seven appropriate solution. “Caravella”, a joint project under years were registered on AIM Italia. AIM Italia48 is the scrutiny by FII and the European Investment Fund Italian Stock Exchange’s market, specifically designed (EIF) has the objective to foster investments of small to enable small and medium-size Italian enterprises VC operators (like business angels) by matching and with high growth potential to access capital markets. eventually doubling their commitments. AIM Italia is expected to offer both a faster and a more

47 Introduced by the Budget Law 2015, art. 1, paragraphs 37–45.

48 Created on March 1st, 2012 through the merger of two markets (AIM Italia and MAC)

Page 46

2.4 Spain VC raised increased to EUR 197 m, but the first Miguel Fernández Acevedo and Blanca Navarro Perez (ICO) estimate for 2015 is EUR 77 m, slightly above the minimum amount of EUR 58 m in 2013. Early-stage

operations have been the main focus of this new • In Spain, the private equity market is less money raised over the past few years. In terms of the developed than it is in other European countries. number of funds, the development is quite similar to the This shortfall is primarily due to three factors: the amount raised. unique structure of Spanish companies, which are, on average, small; the suboptimal average size of Figure 39: Total funds raised by Spanish VC firms private equity firms in Spain, which restricts their ability to invest properly and to grow; and the culture Fundraising in EUR m Number of funds of debt financing. 450 18

400 16 • The factors mentioned above traditionally led to 350 14 an increased reliance on the banking sector as compared to the private equity industry for financing. 300 12 A well-developed private equity sector has proved to 250 10 be very positive in other countries; accordingly, the 200 8 growing awareness of the advantages a large and well-developed private equity market would provide 150 6 has led to some initiatives to promote the 100 4

development of this sector: the creation of Fond-ICO 50 2 Global is the main one among them. 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 • Despite the difficulties, private equity as a whole Early stage Later stage venture Balanced Number of funds and venture capital in particular were growing until the arrival of the global financial crisis that Source: Invest Europe / PEREP_Analytics interrupted the growth trend in this sector. This A quite similar development can also be observed in growth trend resumed slightly in 2014 when the effective investments in companies (in terms of Spanish economy began to grow again, but 2015 industry). The investment volume before the crisis (e.g. figures were still well below pre-crisis levels. 2007) had not been reached by 2015. Figure 40 shows that after 2008 the volume of investment by VC firms 2.4.1 Development of the VC market fell sharply from EUR 500 m to around EUR 100 m. The origin of venture capital in Spain can be placed in Three years later it had fallen to around EUR 80 m of the mid-1980s, more specifically in 1986, when the investment (2012, 2013 and 2014), in 2015 the Spanish Government approved a set of rules designed EUR 100 m level had once again been exceeded to monitor this sector49 and a specific state owned (EUR 105 m), but is in any case still far from its pre- instrument (AXIS50) was created to operate there. crisis level. In terms of the number of companies VC During the late 1980s and, especially, during the firms invested in, that number has remained quite 1990s, the VC sector developed rapidly, but as this stable in the last four years, between 86 and report will show, the development of this sector has not 97 companies per year, but well below the 169 com- reached the level of that in countries like the United panies which received investment funds in 2008. States or the United Kingdom. Continuing with investments, let us look at the number Venture capital has been severely affected by the of investments in companies in terms of market (see economic and financial crisis. This is clearly visible in Figure 41). The overall amount in these terms is slightly all statistics, including those about fundraising. As can higher than in industry terms because of the be observed in Figure 39, the overall volume of VC importance of foreign actors in the Spanish market. funds raised began to fall in 2007 and 2008 and the Otherwise, the trend is quite similar to the one in terms volume remained low until 2015. In 2014 the amount of of industry, but in this case, the overall amount of investment made in 2015 was the highest it had been

49 Real Decreto Ley 1/1986 since 2009 (EUR 156 m in 2015). This volume is well

50 Axis Participaciones Empresariales is ICO’s branch in charge of the below the maximum reached in 2008 (EUR 523 m). managing of Fond-ICO Global The biggest part of these investments went to Spanish companies that were at the start-up stage (EUR 92 m

Page 47 Building Momentum in Venture Capital across Europe

in 2015). In terms of the number of companies that 2.4.2 Public policies in VC received investment in 2014 and 2015 the final data The weaknesses of the Spanish VC sector were well listed around 80 companies – around half of the known even before the crisis, but the severe credit 170 companies that received investments in 2008. restrictions that emerged, especially from 2008 onward, were the starting point for some changes in public Figure 40: Investments by Spanish VC firms policies. One relevant change was the new plan of Investments in EUR m Number of deals support for entrepreneurs approved by the Spanish Government in February 2013. Among many other 600 180 measures,51 its main purpose was to support the banking disintermediation and private equity, including 500 150 the creation of a new Fund of funds charged with investing in private equity firms, especially to support 400 120 projects related to the internationalization of the

300 90 Spanish economy and to encourage productivity gains. So, the Spanish focus was wider than the narrow focus

200 60 on venture capital only, trying to promote the development of private equity as a whole, including

100 30 venture capital.

0 0 Despite the other instruments, discussed in section 2007 2008 2009 2010 2011 2012 2013 2014 2015 2.4.1 (Fond-ICOpyme and Isabel La Católica), that ICO Seed Start-up Later stage venture Number of deals implemented in the VC market, it is worth focussing the Source: Invest Europe / PEREP_Analytics analysis on Fond-ICO Global. It was created during the spring of 2013 with the aim of supporting the creation Figure 41: VC investments into Spanish companies of new funds (establishing new VC funds, both Spanish Investments in EUR m Number of deals and international, with the main aim of investing in Spain), in the form of a fund of funds. The funds of 600 180 funds structure was chosen because it is, e.g.

500 150 according to Kraemer-Eis et al. (2016), an efficient public-private VC scheme. Although the objective is

400 120 private equity as a whole, venture capital has played a very important role from the very beginning. So, Fond-

300 90 ICO Global, after hardly three years of existence, has reached a remarkable position in the VC market. 200 60 Focusing on Fond-ICO Global’s achievements in VC52, 100 30 the main conclusion is that Fond-ICO Global has been fundamental for the development of the sector. Fond- 0 0 ICO Global’s investments (see Figure 42) amounted to 2007 2008 2009 2010 2011 2012 2013 2014 2015 more than EUR 24 m in 2013 (23.3 % out of all VC Seed Start-up Later stage venture Number of deals investments made in Spain). In Spain, its investment Source: Invest Europe / PEREP_Analytics dropped to EUR 16 m in 2014 (16.2 % of all VC investments made in Spain).53 Finally, in 2015, Fond- In terms of sectoral breakdown, in 2015 almost half of ICO Global’s investments grew to EUR 37 m (23.7 % of all the investments made (in terms of market) went to all investments made in the Spanish VC sector). Life Sciences (EUR 75 m), followed by the Accordingly, Fond-ICO Global investments have Communications sector (EUR 45 m) and Computer and remained a very relevant investor in the Spanish VC Consumer electronics (almost EUR 14 m). In 2014, sector. these three sectors also came in first, but in a different order: the first was Communications, followed by 51 A VAT reform or investment incentives were the most important ones. Computer and Consumer electronics and then Life 52 Sciences. VC corresponds to the Fond-ICO Global categories of VC, Incubation and Technology Transfer

53 Global investments of Fond-ICO Global (including investments carried out in other countries were EUR 24 m in 2013 and 2014, and EUR 55 m in 2015

Page 48 Country Reports – Spain

Figure 42: Investments of Fond-ICO Global and of already approved EUR 1.1 bn that Fond-ICO Global other investors in the Spanish VC market will invest in private equity as a whole have so far Investments in EUR m Market share in per cent generated a compromise of investment of at least EUR 4.1 bn by the selected funds in Spain. Moving on 160 40 to VC, the EUR 256 m approved by Fond-ICO Global 140 35 to be invested in the VC sector have so far generated a compromise of investment in Spain of EUR 793 m54. 120 30

100 25 2.4.3 Specific challenges and needs

80 20 As previously pointed out, according to official data, the main challenge facing the Spanish Private Equity 60 15 market (including the VC segment), is to substantially

40 10 increase in size. Compared to its main Spanish economic competitors, the VC sector is relatively small, 20 5 so some measures have to be taken in order to help 0 0 develop this sector. 2012 2013 2014 2015

Fond-ICO Global Rest of the sector Share Fond-ICO Global Several factors account for the relatively small size of Source: Invest Europe / PEREP_Analytics the Spanish VC sector. One possible reason is the small size of Spanish companies; the comparatively The ordinary mechanism of Fond-ICO Global begins small number of medium-size companies and their with the public tendering processes to select general focus on specific sectors has been argued55 as a partners who then establish new VC funds. Under reason to justify this underdevelopment. Another factor some conditions, Fond-ICO Global invests in a is the configuration of the Spanish private equity partnership with other limited partners in the selected th operators; according to Invest Europe data, in 2014 funds. Fond-ICO Global finished its 7 tender in there were 137 private equity operators (135 in 2013) October 2016. These seven public tenders attracted and 76 of them were focused on venture capital. In great attendance of private equity general partners 2015 the number had increased to 142 (all the growth (many of them coming from outside Spain): more than has been in the VC funds sector, because the number 150 candidates (they are not all different because of funds has gone from 76 to 81). The Spanish some of them participated again even if they were not difference was not the number, but its average size; selected the first time) participated to be one of the according to Invest Europe, the average size of a 48 funds selected to receive an overall investment of Spanish private equity firm was EUR 104 m in 2014, more than EUR 1.1 bn. Fond-ICO Global’s assets total declining to even EUR 97 m in 2015 (volume of capital EUR 1.5 bn, so Fond-ICO Global will continue with its under management), which is almost a third of the EUR public tenders until it has allocated the whole amount. 278 m EU- average (in 2015). The difference is smaller The breakdown of the EUR 1.1 bn already allocated in the case of the VC sector, with an average capital of shows that EUR 256 m is the maximum amount EUR 38 m under management in the case of Spanish authorized for VC so far. VC firms as compared to the EUR 71 m (in 2015) of the average VC firm in the EU (see Figure 43). Public tendering processes aim to select VC funds, incubation and technology transfer funds, and growth funds. Nevertheless, to provide VC is Fond-ICO Global’s main objective in terms of the number of funds selected.

Following the tenders and after an established period to formalise the compromise between Fond-ICO Global 54 In July 2016 ICO signed a loan agreement with the European Investment and the general partner, Fond-ICO Global formalises Bank for EUR 250 m that will allow the EIB to intervene as a co-investor in its compromise of investment alongside all the other Fond-ICO Global. EIB will co-invest in the funds selected by Fond-ICO Global with ICO, increasing the money available and thus the liquidity of the VC limited partners. Generally speaking, Fond-ICO Global market. will always be a limited partner while the general 55 E.g. El capital riesgo en España: evolución y retos. La aparición de Fond- partner will be a separate private company. Fond-ICO ICO Global. Blanca Navarro, Carlos Gómez and Miguel Fernández. Anuario Global only invests in funds with a minimum de Capital Riesgo 2014, Madrid 2015 compromise of investment in Spain: accordingly, the

Page 49 Building Momentum in Venture Capital across Europe

Figure 43: Average fund size of Spanish private This is especially visible in terms of amounts: the total equity companies amount of divestment reached EUR 297 m in 2007 and Capital under management in EUR m since then the annual amount of divestment has remained well below that. The best year was 2010 250 231 (EUR 148 m), but 2014 (EUR 18 m) and 2015 216 (EUR 24 m), show that the market is still far from 200 recovery. The breakdown of these amounts shows that in the last years the biggest amounts came from trade 150 135 133 sales followed by write-offs and sales to another private equity house. In any case, these sales to other private 104 97 100 equity houses have dramatically diminished compared with the total amount of sales in 2007

50 41 38 Figure 44: Volume of VC divestments in Spain

0 Divestments in EUR m All private equity Venture capital Buyout investors Generalist investors investors investors 70

2014 2015 60 50 Source: Invest Europe / PEREP_Analytics 40 The above mentioned factors (size of companies and 30 insufficient structure in the private equity sector), may be reasons for the intensive use of banks to finance 20 operations. As a consequence, some needs for this 10 sector may be enounced: the main one would be 0 strengthening the current operators and encouraging 2007 2008 2009 2010 2011 2012 2013 2014 2015 the establishment of new ones. As illustrated in the Divestment by other means Divestment by write-off previous section, some measures have been taken Repayment of principal loans Repayment of silent partnerships Sale to management Sale to financial institution along these lines by the public sector: public entities Sale to another private equity house Divestment by public offering have created new instruments to support the private Divestment by trade sale equity sector in Spain and the regulations have been adapted in order to respond to the needs of this sector. Source: Invest Europe / PEREP_Analytics Additionally, legislative reforms have been introduced Figure 45: Number of VC divestments in Spain to encourage the creation of new funds. Number of exit deals

Another relevant challenge according to the main 350 56 actors in the Spanish market is to strengthen the 300 market as a whole. The market needs time to develop 250 naturally in a range of areas, one of which is 200 divestment structure. It is very important to ensure that 150 there is enough of a market to reabsorb the companies, in order to allow VC firms to invest in new projects. In 100 this sense, the economic crisis has pointed out that the 50 market in Spain is not as deep as it should be to allow 0 VC firms to divest easily. 2007 2008 2009 2010 2011 2012 2013 2014 2015 Divestment by other means Divestment by write-off Figure 44 and Figure 45 show how divestments fell Repayment of principal loans Repayment of silent partnerships Sale to management Sale to financial institution dramatically during the economic and financial crisis Sale to another private equity house Divestment by public offering (both are market statistics, because the disaggregation Divestment by trade sale of VC divestments in industry terms is not available). Source: Invest Europe / PEREP_Analytics

56 This report of a Spanish Venture capital website is a good example of the common views on the sector: https://www.webcapitalriesgo.com/descargas/5715_10_14_96715569.pdf

Page 50 Country Reports – Spain

The number of divestment operations follows quite a More generally, these figures illustrate the need for different trend. From the 40 divestment operations in intensifying public policies in order to strengthen this 2007, the number of operations fell to around 20 in sector and at least be at similar levels compared to the 2009. In 2012, sales to financial institutions helped to EU average. push the number up to 66 operations, but in 2014 and 2015 the number of operations remained slightly above 2.4.4 Policy recommendations 20. It is noticeable that there have been no IPOs since Although the measures already in place are showing 2007 and, on the contrary, the majority of operations positive signs, it is necessary to deepen the current line are trade sales, write-offs and sales to management. of work to strengthen the Spanish private equity sector (and specifically VC activities) with the aim of providing Coming back to the point we made earlier, the main an alternative and reliable source of financing for challenge is to foster the development of the VC sector Spanish firms. Accordingly, some specific policy after some difficult years. Figure 46 shows the recommendations should be made: percentage of VC over GDP in the last years. Even though this percentage was quite small in 2007 or • Track the legislative reforms already in place 2008, it dropped in 2009 and has not recovered since (especially the Entrepreneurs Act and the fiscal then. In 2015, market statistics showed some recovery policies) to be able to reform and improve the due to the entrance of foreign investors, but it is still far framework for venture capital. In this sense, it would be from pre-crisis levels. advisable to make the transfer of basic research into VC easier. Figure 46: VC investment rate fell to a low level • VC investments in per cent of GDP Maintain the public sector effort to promote the development of Spanish Private Equity, especially in all 0.050 the initial stages of Private Equity and with more 0.045 attention to sectors like nanotechnology and 0.040 biotechnology. The last objective is to reinforce the 0.035 private VC sector, accordingly, provided that current 0.030 efforts (especially Fond-ICO Global) have positive 0.025 results, these efforts should be maintained and even 0.020 reinforced in order to continue acting as a catalyst for 0.015 Spanish private VC sector.

0.010

0.005 The Spanish VC sector lacks funds that are large

0.000 enough. Accordingly, the public efforts already in place 2007 2008 2009 2010 2011 2012 2013 2014 2015 must be maintained or even reinforced, increasing VC investments of Spanish institutional investors coordination within the public sector. VC investments into Spanish start-ups

Source: Invest Europe / PEREP_Analytics, own calculations.

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2.5 United Kingdom 2.5.1 Development of the VC market Matt Adey and Dan van der Schans (British Business Bank) VC is a well-established funding source for UK businesses, with the establishment of VC funds dating

back to before the 1980’s.59 Venture capitalists are the • Venture capital (VC) is well established in the UK. most active type of equity investor in UK equity The UK is Europe’s largest VC market, receiving markets, but there is a diverse range of other types of 22.6 % of all VC investment in 2015. equity investors including business angels, private investors and more recently crowd funders providing • Total VC fundraising in the UK reached a nine 60 funding to support growing businesses. year high in 2015 (EUR 1.7 bn) driven by increases in fund raising for later stage VC funding. UK VC markets experienced a large decline in fund raising during the financial crisis of 2008, with VC fund • UK VC markets in 2015 showed some signs of raising falling by 67 % between 2008 and 2010 (Figure softening as deal numbers fell by 38 % compared to 47). The crisis had a large impact on investor 2014. Investment value was broadly similar to 2014, confidence and liquidity; which led to private investors indicating larger deals, especially for later stage VC moving towards safer and more liquid investments. deals. Since 2011 VC markets have picked up, especially for funds focused on early stage VC. In 2015, total Equity finance is an important funding source for VC fundraising in the UK reached EUR 1.7 bn, a nine business start-up and business with the potential for year high surpassing 2007 levels, driven by large very high growth, but only a small proportion of UK increases in fund raising for later stage VC funding. businesses (around 1 %) have used equity funding in However, this increase in later stage VC funding is due the previous three years. Equity finance is therefore to the fund raising activities of one fund rather than a beneficial for businesses that are too risky or lack reflection of wider improvements in later stage funding. security for debt finance, and in these cases, equity The number of VC funds successfully closing their finance is often the most suitable source of funding fundraising in 2015 is 12, down from 18 in 2014. Funds available. raised for VC formed 7.8 % of all PE fundraising in 2015. Venture capital (VC) is well established in the UK and the UK is Europe’s largest VC market. The UK received Figure 47: Venture capital Funds raised per year by the largest proportion of venture capital (VC) funding in fund stage focus Europe, receiving 22.6 % of all VC investment in 2015. Fundraising in EUR m Number of funds UK companies received EUR 858 m of VC funding, forming 0.033 % of GDP, ahead of the European 2,500 25 average of 0.024 %, but behind Finland, Switzerland,

Sweden and Ireland. Levels of VC investment in the 2,000 20 UK are also significantly behind US levels. Research suggests the US market is more developed than that in 1,500 15 the UK with a greater number of funds and greater fund specialization leading to greater levels of funding for US companies.57 1,000 10

Whilst the UK performs relatively well in creating new 500 5 businesses, it is less effective at growing them 58 compared to other countries. Equity finance can 0 0 benefit scale up companies which are important for 2007 2008 2009 2010 2011 2012 2013 2014 2015 increasing productivity and growth. Early stage Later stage venture Balanced Number of funds

Source: Invest Europe / PEREP_Analytics

57 http://british-business-bank.co.uk/wp-content/uploads/2016/02/british- 59 http://www.bankofengland.co.uk/archive/Documents/historicpubs/qb/1984/q business-bank-small-business-finance-markets-report-2015-16.pdf b84q2207211.pdf

58 http://british-business-bank.co.uk/wp-content/uploads/2016/02/british- 60 http://british-business-bank.co.uk/wp-content/uploads/2016/05/97-Small- business-bank-small-business-finance-markets-report-2015-16.pdf Business-Equity-Investment-Tracker-Report.pdf

Page 53 Building Momentum in Venture Capital across Europe

In 2015, 224 UK companies received VC funding to the Figure 49: VC investments by UK VC firms (funds) value of EUR 858 m (Figure 48). Deal numbers fell by Investments in EUR m Number of deals 38 %, compared to 2014 whilst investment value was 2,000 1,000 broadly similar to 2014 increasing by just 1 %. This indicates larger deals, especially for later stage VC 1,800 900 deals. UK VC markets showed signs of softening in 1,600 800 2015 as investors became more cautious due to global 1,400 700 uncertainty. In terms of long run trends, 2015 1,200 600 investment figures were considerably down from the 1,000 500 market peak in 2008 when deal numbers were 64 % 800 400 higher and investment values were 44 % higher, but 600 300 deal numbers were relatively flat between 2010 and 2014. Investment value figures increased in 2014, and 400 200 were maintained in 2015. 200 100 0 0 Figure 48: VC investments into UK companies 2007 2008 2009 2010 2011 2012 2013 2014 2015 Seed Start-up Later stage venture Number of deals Investments in EUR m Number of deals

2,000 1,000 Source: Invest Europe / PEREP_Analytics

1,800 900 Sectoral distribution of VC investment by value in 2015

1,600 800 (Market statistics) shows that companies in the life

1,400 700 science sector received the greatest amount of funding (EUR 246 m) forming 29 %, but computer and 1,200 600 consumer electronics (22 %) and Communications 1,000 500 (19 %) also received large amounts of funding in 2015. 800 400 These sectors also formed the three largest sectors in 600 300 terms of number of investments. Around 40 % of 400 200 investments can be classified as high-technology (30 %

200 100 by value).

0 0 2007 2008 2009 2010 2011 2012 2013 2014 2.5.2 Role of the national development bank The British Business Bank is a Government owned Seed Start-up Later stage venture Number of deals financial institution established to support economic Source: Invest Europe / PEREP_Analytics growth by bringing together public and private sector The majority of VC investments (60 %) occured at the sources of capital to create more effective and efficient start-up stage, with just 5 % at the seed stage in 2015. finance markets for smaller businesses in the UK. The 38 % of investments were at the later stage in 2015, a British Business Bank received State Aid clearance similar proportion to 2014, but higher than 2012 and from the European Commission to operate as a 2013 levels when it was around 30 %. Government owned financial institution in October 2014. The British Business Bank has four strategic Industry statistics showing investments made by UK objectives: VC funds regardless of where portfolio companies are based show a similar trend over time to the market 1. To increase the supply of finance to smaller statistics (Figure 49). The number of deals invested in businesses in areas where markets do not work well. by UK funds is higher than the market figures, suggesting a net balance of UK funds investing outside 2. To help create a more diverse finance market for of the UK. It is also worth noting that the US provided smaller businesses with a greater choice of options and around 10 % of capital to UK Private Equity backed providers. companies in 2015, showing that equity markets are international. 3. To help ensure better provision of information in the market, connecting smaller businesses and finance providers.

4. To manage taxpayers’ resources efficiently.

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The Bank does this by working through partner The British Business Bank venture capital programmes organisations like banks, venture capital funds, finance seek to stimulate this part of the market by encouraging platforms, etc. and by using these organisations’ private sector investment at an earlier-stage, and by existing distribution networks, rather than having its supporting the development of a long-term market for own branch network or making funding directly angel investment. Enterprise Capital Funds (ECFs) available to SMEs. Equity funds supported by the were established in 2006 and are the bank’s main British Business Bank’s programmes combine private programme for early stage venture capital targeted at and public money to make commercially focused equity addressing the equity gap. Government funding is used investments in businesses with high growth potential . alongside private sector investment to establish funds The British Business Bank’s venture capital program- operated by private sector fund managers targeting mes are focused on supporting a vibrant and diverse investments of up to GBP 5 m in SMEs that have the venture capital market to support early stage and high- potential to provide good financial returns. Government growth firms in the UK, in line with the Bank’s overall provides up to two thirds of funding (up to GBP 50 m) objectives to increase the supply of financing and to for each ECF fund, which is matched by at least one support a more diverse finance market. third private sector investment.

As of the end of December 2015, the British Business The funds are an approved State Aid and, following Bank’s current venture capital programmes had changes to the terms of EU approval, these arran- supported 634 businesses with approximately GBP gements apply to funds raised from January 2014 2.7 bn of equity funding (Table 1). Based on the onwards. The previous maximum ECF deal size was number of visible investments within the Beauhurst GBP 2 m, and the increased limit reflects the increa- database, British Business Bank programmes are sing size of the equity gap over time. The structure of estimated to have supported around 6 % of all equity HMG investment means that private sector investors deals with these deals forming around 9 % of the will see a slightly greater loss on funds which do not overall invested equity amount. perform, but they are granted a larger share of profit from successful funds to incentivise their involvement. Table 1: British Business Bank Programme The ECF programme is a rolling programme with a investments (As at Q4 2015) small number of new funds established each year. Number of unique Total There are now 19 ECFs with total investment capacity

SMEs funded investment of GBP 666 m. Enterprise Capital Funds 249 GBP 330 m (ECF) In addition to ECFs, the Business Angel Co-fund was VC Catalyst 35 GBP 105 m launched in 2011 to improve the functioning of the UKIIF 289 GBP 2.2 bn market. It is a GBP 50 m fund that invests alongside Business Angel Syndicates. The fund will only invest Angel Co Fund 61 GBP 145 m where three or more business angels are investing and Total 634 GBP 2.7 bn where there is evidence of appropriate due diligence. Source: British Business Bank Management Information (Includes The Co-fund provides matched funding of between overseas investments) GBP 50,000 and GBP 1 m in investment rounds ranging from GBP 200,000 upwards. The fund co- The rationale for the bank’s equity programmes is invests alongside lead Business Angels who are based on addressing market failures affecting the responsible for sourcing investments, carrying out supply of equity finance. There are long-standing appropriate due diligence and submitting an investment structural market failures in the provision of venture paper for approval by the Co-fund investment capital to smaller businesses, which are commonly committee. known as the “equity gap” and are most acute for businesses seeking smaller amounts of equity finance. The process of undertaking innovation or the creation The high costs of due diligence, relative to value of the of new products often generates wider benefits for investment deal size, make smaller equity investments other agents in the economy. Due to the divergence of commercially difficult, with venture capitalists focusing private and social benefits, there is an under supply of on fewer, larger investments in more established equity finance to innovative high growth potential businesses. This leads to a lower supply of venture businesses more generally. capital to early-stage and growing SMEs.

Page 55 Building Momentum in Venture Capital across Europe

The UK Innovation Investment Fund (UKIIF) • Sustainable financial returns given the risk established in 2009 supports the creation of viable profile. Venture capital returns have improved in equity funds targeting UK high growth technology- recent years due to the strong exit environment with an based businesses. GBP 150 m was committed by the increased number of IPO and trade sales, but British UK government to two underlying funds of funds, which Venture Capital Association figures show the 10 year in turn invested in underlying VC funds, capable of IRR is 4.6 %.62 This is lower than the 7.6 % return from making GBP 2.2 bn of investment capital available to investing in publicly quoted shares, which are lower risk companies. UKIIF acted as a cornerstone investor and Low financial returns will reduce the attractiveness of helped sustain VC markets at a time when they were VC as an asset class for institutional investors. vulnerable. It also addresses long-term structural issues in the funding of high technology businesses. • Increasing smaller business awareness and The UK Government has invested on a pari passu demand for equity finance: Demand side issues basis with private investors and as a result, funds are combine with supply side issues to impede the able to make larger investments than other British effectiveness of equity markets for SMEs. Small Business Bank funds to enable the scaling up of businesses lack awareness of different finance options businesses. available to them, and as a result many SMEs do not know who to approach or how best to seek equity Additionally, later-stage venture capital markets - which finance. For instance, 60 % of SMEs are aware of used to be well served by institutional investors, have venture capitalists but only 22 % are aware of a specific struggled for liquidity in recent years (2008–2013). venture capitalist to approach.63 Greater uncertainty in the market combined with investors’ lower risk appetite mean that it has become 2.5.4 Policy recommendations more challenging for commercially viable funds to UK equity markets continue to perform strongly but close. The British Business Bank addresses this there are a number of improvements the UK could cyclical market impediment through the VC Catalyst address to enable its venture capital markets to Fund by making commercial investments in viable become even more effective at meeting the funding venture capital funds that might otherwise fail to reach needs of fast growing businesses: a satisfactory “first close”. This enables funds to commence investing sooner than they otherwise could • Increase the availability of equity finance to have done. The programme usually invests between businesses outside of London. The supply of VC is GBP 5 m to GBP 10 m in funds nearing first close. uneven in the UK. Whilst there are benefits to clustering, the location of VC and PE fund managers 2.5.3 Specific challenges and needs does not fully reflect the incidence of high growth Whilst the UK VC market performs relatively well businesses in the wider business population, which compared to markets in Europe overall, there are a may constrain their ability to grow. The British Business number of challenges which reduce the effectiveness Bank has recently created the Northern Powerhouse of the market in meeting the funding needs of growing and Midlands Engine investment funds to specifically UK businesses. increase equity finance available outside of London.64

• Regional differences in equity use: Equity finance is heavily concentrated in London, the UK’s capital city. Beauhurst data shows that regions outside of London are under-represented in terms of their share of investments. In 2015, companies located in London received 47 % by number and 57 % by value of all equity investment, despite 21 % of the UK’s high growth businesses being located in London. This

demonstrates the potential to encourage more equity 62 http://www.bvca.co.uk/Portals/0/library/documents/Performance%20Measur investment in high growth businesses in other parts of ement%20Survey/2014%20Performance%20Measurement%20Survey.pdf 61 the UK. 63 http://british-business-bank.co.uk/wp-content/uploads/2016/02/Business- Finance-2015-SME-survey-report.pdf

64 http://british-business-bank.co.uk/ourpartners/midlands-engine-investment- 61 http://british-business-bank.co.uk/wp-content/uploads/2016/02/british- fund/ and http://british-business-bank.co.uk/ourpartners/northern-powerhouse- business-bank-small-business-finance-markets-report-2015-16.pdf investment-fund/

Page 56 Country Reports – United Kingdom

• Increase access to later stage funding to enable Preqin67 shows US funds are on average 1.6 times scale-up companies to succeed: The amount of later larger than UK funds, which contributes to US com- stage VC funding has lagged behind start-up funding in panies receiving nearly twice as much funding as UK recent years65, which may have held back the number companies. A recent report68 suggests differences in of successful scale up companies. Of the 166 unicorn66 deal sizes between the UK and the United States are businesses in existence today, the UK has 5. Even most apparent in later funding rounds. A lack of later when differences in GDP are taken into account, this stage funding results in businesses finding the process significantly lags behind the United States (96). One of raising equity finance difficult and time consuming, factor holding back the availability of later stage funding which can impede their business growth. ■ may be fund size. British Business Bank analysis of

65 Invest Europe market figures show later stage VC funding has been relatively weak from 2009 onwards, with lower investment values figures than 67 http://british-business-bank.co.uk/wp-content/uploads/2016/02/british- start-ups in 2012 and 2013. business-bank-small-business-finance-markets-report-2015-16.pdf

66 Unicorn businesses are defined as private companies valued at USD 1bn 68 https://www.home.barclays/content/dam/barclayspublic/docs/BarclaysNews/ and above. CB Insights: https://www.cbinsights.com/research-unicorn- 2016/April/Scale%20up%20UK_Growing%20Businesses_Growing%20our%2 companies (Accessed 08/06/2016) 0Economy.pdf

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BVK (2016), Private Equity-Prognose 2016 – Erwar- Lerner, J. (2009), Boulevard of broken dreams: why tungen der deutschen Beteiligungsgesellschaften zur public efforts to boost entrepreneurship and venture Marktentwicklung, BVK-Study, Berlin, February 2016. capital have failed – and what to do about it, Princeton University Press. Da Rin, M., Hellman, T. F. and M. Puri (2011), A survey of venture capital research, NBER working Mazzucato, M. (2015), The entrepreneurial state: paper n°17523. debunking public vs. private sector myths, Revised edition, Anthem Press, 2015. Dilger, R. J. (2016), SBA Small Business Investment Company Program, CRS Report R41456. Mulcahy, D., Weeks, B. and H. S. Bradley (2012), We Have Met the Enemy … and He Is Us – Lessons from European Commission (2015). Assessing the Twenty Years of the Kauffman Foundation’s Potential for EU Investment in Venture Capital and Investments in Venture Capital Funds and The Triumph Other Risk Capital Fund of Funds. Final Report, of Hope over Experience; Kauffman Foundation. Brussels. Navarro, B., Gómez, C. and M. Fernández (2015), EVCA (2014), 2013 Pan-European Private Equity Anuario de Capital Riesgo 2014, Madrid 2015. Performance Benchmarks Study“, June 2014. OECD (2015), International comparability of venture Giot, P., Hege, U. and A. Schwienbacher (2014), capital data, in Entrepreneurship at a Glance 2015, Are Novice Private Equity Funds Risk-Takers? OECD Publishing, Paris. DOI: Evidence From a Comparison With Established Funds, http://dx.doi.org/10.1787/entrepreneur_aag-2015-32- Journal of Corporate Finance, vol. 27, 2014, p. 55–71. en.

Gompers, P., Kovner, A., Lerner, J. and Popov, A. and P. Roosenboom (2009), Does private D. Scharfstein (2008), Venture capital investment equity investment spur innovation? Evidence from cycles: the impact of public markets, Journal of Europe, ECB Working Paper, No. 1063. Financial Economics, 87: 1–23. Ritter, J. (2016), Initial Public Offerings: VC-backed Hall, B. H. (2002), The financing of research and IPO Statistics Through 2015, Cordell Professor of development, Oxford Review of Economic Policy, Finance, University of Florida, January 6, 2016, 18(1): 35–51. http://bear.warrington.ufl.edu/ritter.

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Appendix

Table 2: Venture capital investment stage definitions by Invest Europe and NVCA

Invest Europe NVCA Seed Seed Financing provided to research, assess and develop an initial concept This stage is a relatively small amount of capital provided to an before a business has reached the start-up phase. inventor or entrepreneur to prove a concept. This involves product development and market research as well as building a management team and developing a business plan, if the initial steps are successful. This is a pre-marketing stage.

Start-up Early stage financing Financing provided to companies for product development and initial This stage provides financing to companies completing development marketing. Companies may be in the process of being set up or may where products are mostly in testing or pilot production. In some have been in business for a short time, but have not sold their product cases, product may have just been made commercially available. commercially. Companies may be in the process of organizing or they may already be in business for three years or less. Usually such firms will have made market studies, assembled the key management, developed a business plan, and are ready or have already started conducting business.

Expansion stage financing This stage involves working capital for the initial expansion of a company that is producing and shipping and has growing accounts receivables and inventories. It may or may not be showing a profit. Some of the uses of capital may include further plant expansion, marketing, working capital, or development of an improved product. Later stage venture More institutional investors are more likely to be included along with Financing provided for the expansion of an operating company, which initial investors from previous rounds. The venture capitalist’s role in may or may not be breaking even or trading profitably. Late stage this stage evolves from a supportive role to a more strategic role. venture tends to be financing into companies already backed by VCs, therefore they would be C or D rounds of financing . Later stage financing Capital in this stage is provided for companies that have reached a fairly stable growth rate; that is, not growing as fast as the rates attained in the expansion stages. Again, these companies may or may not be profitable, but are more likely to be than in previous stages of development. Other financial characteristics of these companies include positive cash flow. This also includes companies considering IPO.

Source: Invest Europe and NVCA Yearbook 2015, following OECD (2015).

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